7: Inflation

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Page ID: 287950

Martin Medeiros
Chabot College

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Learning Objectives

Upon completion of this unit, you will be able to

define inflation
understand the effects inflation has on market behavior
distinguish between the different types of inflation measurements
understand how the Bureau of Labor Statistics compiles inflation data
identify the limitations of the consumer price index (CPI)

Note: Inflation is a complex and important subject, so this chapter is longer than others. Take it slowly and be sure to ask questions if anything isn't clear.

7.1: Introduction
This page discusses how prices communicate information in the marketplace and the complexities inflation introduces to economic assessment. It contrasts real values, which are adjusted for inflation and provide clearer insights into economic activity, with nominal values that reflect current prices. Economists favor real values for accurate temporal comparisons, highlighting how inflation affects measurements like GDP through the gap between real and nominal figures.
7.2: Understanding Inflation
This page emphasizes the importance of distinguishing between nominal and real income when evaluating economic well-being, noting that an increase in income doesn't necessarily reflect improved purchasing power if inflation rises. It highlights the role of price indexes in adjusting for inflation to assess purchasing power effectively.
7.3: Focusing on the Rate of Change
This page uses a car metaphor to illustrate price changes and inflation rates. A forward-moving car represents rising prices, while a backward-moving car indicates falling prices. Constant speed signifies stable inflation, and a decrease in speed reflects disinflation, where prices rise more slowly. A stopped car that reverses symbolizes deflation, indicating a decrease in average prices. Negative month-to-month inflation suggests that goods and services are becoming less expensive.
7.4: Measures of Inflation
This page elaborates on inflation measurement through various indices like the Consumer Price Index (CPI), Personal Consumption Expenditure Index (PCE), and GDP Price Deflator. Each index serves distinct purposes: the CPI focuses on consumer goods, the PPI on production prices, and the GDP deflator provides a broader view but is published less often. The choice of inflation measure is influenced by market type, desired frequency, and coverage for effective analysis.
7.5: Some Principles of Inflation
This page discusses the uneven impact of inflation, highlighting both its potential benefits and drawbacks. It notes that rising prices can lead to varied income effects, influencing different groups based on their financial situations. It emphasizes the importance of price stability for economic planning, as inflation-induced uncertainty can impede investment and growth.
7.6: How Inflation Affects the Economy
This page discusses the effects of inflation on the economy and market participants, distinguishing between moderate (2-4%) and high, volatile inflation. Moderate inflation fosters stability and allows adjustments for consumers and businesses, particularly benefiting those on fixed incomes. The Federal Reserve aims for a 2% inflation rate to support growth.
7.7: What Causes Inflation?
This page outlines the causes of inflation, including demand-pull, cost-push, and trade factors. Demand-pull inflation arises from high consumer demand, while cost-push inflation originates from increased production costs passed onto consumers. Additionally, tariffs on imports contribute to inflation by raising business costs. Together, these elements influence the overall inflation rate and economic dynamics.
7.8: Consumer Price Index- Introduction
This page discusses the Consumer Price Index (CPI), a crucial economic indicator published monthly by the Bureau of Labor Statistics (BLS) that tracks price changes in a basket of goods and services for urban consumers. While vital for understanding inflation and market activities, some analysts raise concerns about its accuracy and prefer alternative measures.
7.9: Market Basket
This page explains the Consumer Price Index (CPI), which measures monthly price changes for goods and services bought by average consumers. It is based on a market basket of over 2,000 items gathered from consumer expenditure data of more than 30,000 families. Data is sourced from the Consumer Expenditure Survey through diaries and interviews. The Bureau of Labor Statistics (BLS) selects items for the basket and collects price data from about 80,000 items nationwide to compute the CPI.
7.10: Expenditure Weight versus Relative Importance Weight
This page discusses the 2023 Consumer Expenditure Survey, which found a 9.0% increase in average spending by U.S. consumers to $72,967 in 2022. The Bureau of Labor Statistics uses this data to adjust expenditure weights in the Consumer Price Index (CPI), influenced by consumer spending trends and price changes across categories.
7.11: Limitations
This page discusses the limitations of the Consumer Price Index (CPI) as an economic indicator, which includes issues of volatility, quality adjustments, and substitution bias. These flaws can distort true inflation trends, especially in fluctuating categories like food and energy. As a result, the CPI may overstate inflation by approximately 1.
7.12: The Market's Reaction
This page highlights the importance of the Consumer Price Index (CPI) for analysts, as it adjusts economic indicators for inflation, affects income payments and wage adjustments, and influences interest rates through inflation expectations. CPI data release includes statistics that media reports, impacting market reactions to unexpected inflation changes, which in turn affects economic conditions and investment strategies.

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