Chapter 7 homework

• Number 2: Scott Anderson

• Number 4: Eikeem Barron

• Number 10: Kelly Beck

• Number 14: Meghan Bouvier

• Number 16: Thomas Caruso

• Alternate: Matt Herr

Chapter 8

Inflation and Prices

Real vs. Nominal Prices

• Use to compare the price today to the past or future

• Real Accounts for inflation Gas prices in 2002 averaged $1.59. Adjusting for

current inflation gas prices in 1974 would have been $1.57.

• Nominal Current prices Quart of Milk was $0.40 in 1970 and $1.25 in 2000

Example

• 1970 CPI = 38.8

• 1999 CPI = 167

• Was there a little or much inflation?? Much (especially in the 70s and 80s)

• Milk prices were $1.05 in 1999 and $0.65 in 1970

• Was milk more expensive in 1999?

YEARCOMPARISONYEARCOMPARISON

INDOLLARSWANTYEAR PRICECPI

CPI*

• What is 1999 milk in 1970 dollars? (38.8/167)*$1.05 = $0.24 Milk was less expensive in 1999

• What was 1970 milk in 1999 dollars? (167/38.8)*$0.65 = $2.80 Milk was more expensive in 1970

Can we do it??

The following is a list of prices for housing in five different countries along with their CPI.

For which country is the real cost of housing declining? Use year 2 as the base year

in your answer.

Life Lessons

• Sometimes it pays to owe money. Total payments for houses and cars

are generally much higher than the purchase price.

However, going into debt may be cheaper than paying the full price up front.

Inflation reduces the burden of fixed payments.• However, lenders may become reluctant to make loans.

Figure 8.1 Real and Nominal Interest Rates from 1964 to 2004

Measures of Inflation

• The Consumer Price Index (CPI) summarizes movements in the prices faced by consumers.

• Measures how much more (or less) it costs to buy a given market basket from one month, quarter, or year to the next. A market basket is the combination of

goods and services that the typical consumer purchases during the period in question.

Calculating the CPI (cont’d)

• Calculating the CPI involves four steps:

1. Survey consumers.

• The BLS determines what goods and services go in the market basket by conducting extensive surveys of what consumers buy.

• The market basket consists of about 95,000 goods.

Calculating the CPI (cont’d)

2. Survey retailers.

• The BLS surveys about 23,000 retailers in 87 urban areas.

• About 50,000 landlords or tenants are surveyed regarding the housing market.

Calculating the CPI (cont’d)

3. Determine the cost of the market basket.

• The cost of the entire market basket is found by multiplying the price of each good times the quantity in the basket.

4. Compare the cost of the market basket across time periods.

• The base year serves as the basis for comparison with prices in another year.