2.

4: Price Indices and Inflation

Enduring Understanding: an economy’s performance can be measured by different indicators such as

gross domestic product, and the inflation rate.

Learning Objective:

a. Define the consumer price index, inflation, deflation, disinflation, the inflation rate and real
variables
b. Explain how price indices can be used to calculate the inflation rate and to compare nominal
variables over time periods
c. Calculate the CPI, the inflation rate, and changes in real variables

Essential Knowledge: the consumer price index measures the change in income a consumer would need
in order to maintain the same standard of living over time under a new set of prices as under the
original set of prices

2.5: Costs of Inflation

Enduring Understanding: An economy’s performance can be measured by different indicators such as

gross domestic product the inflation rate, and the unemployment rate

Learning Objective: Explain the costs that unexpected inflation (deflation) imposes on individuals and
the economy

Essential Knowledge: Unexpected inflation arbitrarily redistributes wealth from one group of individuals
to another group, such as lenders to borrowers.

2.4 – DAILY VIDEOS

Daily Video 1: focus on Consumer Price Index – a measure of consumer purchasing that can be use to
calculate inflation rate

1. (Pause – 2:06) Respond to the following:

a. What is the Consumer Price Index (CPI)
b. What is a Market Basket and how does it inform the CPI

A. CPI, A measure of the average change over time in the prices paid by consumers for a FIXED
“market basket”
B. Market Basket, every few years, the Bureau of Labor Statistics conducts a “Consumer
Expenditure Survey” of about 24,000 consumers in which they are asked to report on their
spending habits
The market basket refers to the goods and services purchased by consumers

2. (Pause at 3:22) Respond to the following:

a. What is a price index that is measured by the CPI?
 b. Define: inflation,
c. Define: deflation,
d. Define: disinflation (this definition is described by the instructor and not on the slide)
e. What are some factors that YOU THINK might lead to inflation in an economy?

a. Price index: a price index that can be used to calculate the inflation rate
Inflation: is an overall increase in prices. Inflation erodes the purchasing power of a
given income.

Deflation: is an overall decrease in prices. Deflation strengthens the purchasing power

of a given income.
Disinflation: A decrease in the inflation rate which can occur from multiple different factors.

The following responses will can be answered from time 3:25 (Let’s look at an example) to 6:56. The
instructor speaks very quickly so you are urged to stop and rewind to develop a more thorough
understanding of the concepts:

3. (pause at 4:37) How does one calculate a market basket for the base year? And how does one
calculate a market basket for the following year. Why do you suppose economist do not change
quantity?
You calculate the market basket for the base year by taking the prices of items times the quantity of those
items from the base year and adding those together, giving you the market basket value. The market basket
of not the base year is that vear's prices, times the base year quantities. This is because we are trying to
calculate the new sum of money, and there are new prices, but we want to base those prices on the same
quantity number.

4. (pause 4:49) How does one take the market basket and “turn them into CPIs” (AP Classroom,
Speed Demon Lady)?
Market Basket Current Year/Market Basket in Base Year x 100

5. (pause at 6:56) What is the “rate of change” formula and how does it help calculate the Inflation
Rate?
ROC• New-Old/Old x 100

6. (Pause at 7:11) Use the numbers on the screen to respond to the following:
a. Calculate the value of the market basket for each year.
b. Calculate the CPI for each year using the market basket.
c. Calculate the inflation rate from year 1 to year 2.
1. (7x20)+(20×23)+(25×8)«800 year 1 (5.25×20) +(25×23)+(40×8)*1000 year 2
 800/800 × 100= 100 year 1
1000/800 x 100# 125 year 2
c. 125-100/100 x 100- 25% inflation rate

7. What was your answer? Were you correct? Why or why not were you correct?
I had multiple different answers, and they were all correct because I used the formulas, they gave us and
then i plugged in the corresponding numbers and got the same answers as the lady in the video.

Daily Video 2:

8. (pause at 2:15)What is the difference between “nominal” and “real”?

AP Answer: Nominal • variables that have NOT been adjusted for inflation (nominal income: the amount of money
one earns in the form of wages or salary, nominal GDP: the value of an economy output in current dollars, nominal
interest rate: the stated interest rate)
Real » variables that HAVE been adjusted for inflation (real income: the purchasing power of a given wage or
salary, real GDP: the value of an economy's output in inflation-adjusted dollars, real interest rate: the inflation-
adjusted cost of borrowed money)

My Thoughts:
Nominal variables are basic, straight-out measurements that may be a little bit less meaningful or useful than real
variables which have been better adjusted to reflect the real value of money in different situations.

Let’s Look at an Example

9. (pause at 4:32) is the Wage Earner depicted in this lesson better off than in 2010 over 2000?
Explain with reference to REAL and NOMINAL income as well as nominal salary and CPI.
No, it is not because the infiation rate increased from 2010 to 2000, which is not goof for an economy. While
the real amount of money may be more in 2010, the nominal income shows us that just because people have
more money doesn't mean they're better off, this money in 2010 could buy them less than what they were
buying with their 2000's salary. The same with the CPI, its increase is 26.7%

Let’s Practice

10. (Pause at 5:46) is a worker’s nominal wage rate increases from 10-12 per hour and at the same
time the general price level increases by 10 percent the worker’s real wage has:

My Initial Answer (A,B, C, D, E) – GIVE FULL ANSWER

C. Approximately increased by 10%
Why I Chose This Answer: I chose C because while her salary is going up by 20%, the general price level is going
up by 10%, so
20% 10% 310%、
 Was I Correct or Incorrect?
correct
What enabled me to be correct OR what was my erroneous thinking?
I did the calculations necessary to find the correct answer to the problem.

11. (pause at 6:13) Suppose that the consumer price index rises from 100 to 200. From this
information we may conclude:

My Initial Answer (A,B, C, D, E) – GIVE FULL ANSWER

Why I Chose This Answer:

D. The prices in average consumers market are doubled
Was I Correct or Incorrect?
Correct
What enabled me to be correct OR what was my erroneous thinking?
I analyzed the question, and figured out an 100% increase means doubling, giving me answer C

12. (pause at 6:56) Joaquin’s annual salary in 2019 was $50,000. After calculating the inflation rate
using the CPI information (2019 – 100, 2020 – 110), Joaquin realized that the salary increase he
experienced in 2020 resulted in no change to his real income. In order for this to be true,
Joaquin’s salary in 2020 must be:

My Initial Answer (A,B, C, D, E) – GIVE FULL ANSWER

C 55,000
Why I Chose This Answer:
10% (Which is the ROC in the CPI) of 50,000 is 5,000, and so since there's no change the income must beC

Was I Correct or Incorrect?

correct
What enabled me to be correct OR what was my erroneous thinking?
I calculated the ROC in the CPI which allowed me to find a 10% change in the income, and then that would be
canceled out due to the CPl increasing by that percentage.

Daily Video 3: shortcoming of the CPI that may result in overstating inflation rate

13. (Pause at 1:17) Jot down some observations taken from this chart.

14. (pause at 5:21) What are the shortcomings associated with CPI.
 AP Answer:
° FIXED basket - market basket does not change to reflect consumer reaction to changes in relative prices
Consumers substitute toward goods that have become relatively less expensive
Introduction of new goods
The market basket does not reflect the change in purchasing power brought on by the
introduction of new products
New products result in greater variety, which in turn makes each dollar more valuable (ive.
greater purchasing power)
Consumers need fewer doliars to maintain a given standard of living
Music streaming services vs. individual downloads of MP3 files
Unmeasured quality changes
• Il the quality of the good rises (falls) from one year to the next, the value of a dollar rises (falls), even if the
price of the good stays the same
My Thoughts:
The CPI has quite a few shortcomings making it not fully accurate, but it is a still a good measure of the
change in price in different products.

15. (pause at 6:57) With reference to volatility explain why the CPI may not be entirely accurate.
Give an example from the chart on the screen.

Due to extreme volatility, things can be over or under exaggerated which can mess up the CPL. For example,
gasoline is extremely volatile.

16. (pause at 7:48) Explain, in your own words, why it matters if CPI overstates, or understates, the
true inflation rate.
1s importane because the literal government usts the CPI to determine many thing, (cutes) lac things with
social security checks and retirement, which can definitely cause issues with those sums of money.

2.5 Daily Video 1

17. Explain, in your own words, the following:

A. Why is it important for there to be some expectations of price stability for people entering into long
term contracts?

b. Who benefits from inflation? How?

C. Who loses from inflation? How?

a. It's important for there to be expectations because people use these expectations for their decision making,
which causes them to or to not enter into a contract.
1. Beneficiaries are the people who benefit from inflation, like borrowers. This means the people that are
paying money at a fixed amount.
2. For example, lenders lose in inflation as they are receiwing money at a fixed amount. Or. others receiving
money
 17. (pause at 5:53) Which of the following will happen if the expected inflation rate is less than the
actual inflation rate?

My Initial Answer (A,B, C, D, E) – GIVE FULL ANSWER

E. Borrowers of faced interest rate loans will be better off
Why I Chose This Answer:
The people who get loans are expecting inflation to be higher, so they pay more in the beginning, but then they
end up making money because the inflation rate ends up being lower than expected.

Was I Correct or Incorrect?

Correct
What enabled me to be correct OR what was my erroneous thinking?
I used the logic that the earlier examples taught us

18. Sample FRQ: If the GDP Deflator increases unexpectedly, would a borrower with e fixed interest
rate loan be better or worse off? Explain.
The borrower with a fixed-interest rate loan would be better off because the value of the loan repayments (in
terms of how much purchasing power they have) is lower than the borrower expected.

19. Was your answer close to correct or incorrect? Why were you correct or incorrect?
was very correct because i wash aware, we were supposed to pause the video so I learned everything about
the question and it's answer from the AP lady mistakenly, but I understand the question and how to answer
very well now.