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Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,*,The monetary system,prices,and inflation,Outline,What is a monetary system?,Index numbers,The Consumer Price Index(CPI),The CPI and the Inflation Rate,Adjusting the money(nominal)wage for inflation using the CPI,The Costs of Inflation,Is the CPI accurate?,Consequences of overstating inflation,The monetary system,The monetary systems establishes two things:,The unit of value(or account),The medium of exchange,In England,the pound is our unit of value.The price of bus fare,dry cleaning,soft drinks,and GDP is expressed in pounds.,In the U.S.,the dollar serves as the unit of value and medium of exchange.If you want to by goods and services here,you need dollars.,Recall that GDP in 2004 was 11.73 trillion,dollars,This Note Is Legal Tender For All Debts,Public and Private,Fiat Money:,Anything which serves as a means of payment by government declaration,You are willing to accept money not because it is“backed by precious metals;but rather because you know it is generally acceptable in exchange,Index numbers,An,index,is a series of numbers used to track a variables rise or fall over time.,Index numbers are meaningful in a,relative,senseby comparing one periods index number with that of another period.,In general,an index number is calculated as:,Value of the measure in the current period,Value of the measure in the,base,period,100,Example:Violent Acts on TV,We select the year 1996 as our base year,or benchmark period.In that year,there were 10,433 violent acts on TV.Thus,our index for the current year would be calculated as follows,Number of violent acts in the current year,10,433,100,If there were 14,534 acts in 2000,then:,Thus,TV violence increased by 39.3 percent between 1996 and 2000.,Time,prices,Inflation,Inflation is a sustained increasein the prices of goods and services(or the cost of living).To measureinflation,we look at changes in theprice of a market basket of goodsor services households typicallypurchase with their income,We use the CPI to measure changes in the cost of living experienced by households.,The CPI is the“narrow price index in that the market basket used to construct it includes items purchased by households.,Bureau of Labor Statistics economic assistants check the prices of 80,000 items in 30 metropolitan areas each month.,The inflation rate is simply the percentage change in the CPI from one period to the next.,1982-84 is the base period,The Consumer Price Index(CPI),The,BLS,now revises the market basket every 2 years,Consumer Price Index(1982-84=100),Source:,Bureau of Labor Statistics,On average,the prices of goodsand services in the CPI market basketincreased by 3.7%from 1999 to 2000,To compute the 2000 inflation rate,Inflation,2000,=(CPI,2000,CPI,1999,)1 100,Thus we have:,Inflation,2000,=(174.5,168.3)1 100=,3.7 percent,Source:,The Economist,The inflation myth,Inflation cannot by itself decrease average real income.Inflation can shift purchasing power from some groups to others,Inflation in,not,an equal opportunity villain.That is,inflation arbitrarily,and unfairly,redistributes,real purchasing power from some groups to others.,Redistributive Costs of Inflation,The race to stay ahead of inflation,Inflation erodes the purchasing power of income and sets off a race to stay ahead of the cost of living.,Teachers,fireman,truck drivers,nurses,accountants,plumbers,social security recipients,and others strive to increase their incomes so as not to suffer a decrease in their standard of living.,Some groups do better than others.,Machinists,Job description:,Set up and operate a variety of machine tools to produce precision parts and instruments.,Mean,CPI,Year,Annual Wage,(1982-84=100),1995,$31,270,152.4,2005,$34,790,196.4,Source:,Bureau of Labor Statistics,Are machinists better off in 2005?,Why are we smiling?Because our social security benefits are indexed to the CPI,Why doesnt Congress index the minimum wage to the CPI?,Nominal,Real Value,Year,Value,(1982-84),1938,$0.25,$1.77,1949,0.40,1.68,1955,0.75,2.80,1961,1.15,3.85,1966,1.25,3.86,1974,2.00,4.06,1978,2.65,4.06,1989,3.35,2.70,1996,4.75,3.03,2004,5.15,2.73,Value of the Federal Minimum Wage,Source:U.S.Department of Labor,Unexpected inflation redistributes real income from lenders to borrowers,Repayments schedules for most debt contracts are fixed in nominal or money termsthat is,debts are not indexed to inflation.,Inflation erodes the real value of repayments.,Savings&Loan institutions lost money on long term mortgages in the70s and 80s.,We bought this house in 1957 for$19,000.We financed the house on a 30 year mortgage note at 3.5 percent interest.Can you guess what our monthly payment was?,Answer:$85.32,Inflation undermines confidence,in political leaders and institutions,Is the CPI accurate?,The Boskin Commission reported to Congress in 1996 that the CPI over-estimated the actual inflation rate in recent years by an average
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