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Lecture 2

Lecture 2 - Continuation of Ch. 19 Notes on Effects of Unemployment, CPI and Inflation Rates,.docx

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Brock University
Professor Cottrel

10/09/2013 Effects of Unemployment: -Economic Problems (loss of output/loss of skills) -Immense human suffering (illness, breakdowns) -Social Problems (homelessness, crime) Price Level: -The average level of all prices in the economy Inflation: -The rate (%) at which the price level is changing Consumer Price Index (CPI): -The most common measure of the price level -Based on the price of a typical consumer “basket” of goods and services (urban household). -CPI for the BASE PERIOD is always set to 100.  In later/following years, the CPI shows prices as a ratio of the price in the base period. In the economy of ultimate pleasure, the typical urban household consumes the following goods & services… Base Year Current Year Goods Quantity Price ($) Expenditure Price ($) Expenditure ($) ($) Chocolates 100 10 1,000 15 1,500 Ice Wine 50 50 2,500 60 3,000 Back Rubs 70 30 2,100 30 2,100 Total 5,600 6,600 Expenditures: a) What is the value of expenditures in the base year and in the current year? Base Year = $5,600 Current Year = $6,600 *CPI IN THE BASE YEAR IS ALWAYS 100* b) Find the value of the CPI in the current period. Current CPI = (6,600/5,600) x 100 = 117.857 = 117.86 c) What is the inflation rate between the base and current years? Inflations Rate = (P2 – P1/P1) x 100 = (117.86 – 100/ 100) x 100 = 17.86 % The CPI is a fixed base weighted index number.  The CPI in the current year is 117.86  Prices rose (inflated) by 17.86 % from the base year to the current year d) Have the relative prices changed? Yes, the price of chocolate has increased by 50%. = ((15-10)/10) x 100 = 50% Yes, the price of ice wine has increased by 20% = ((60-50)/50) x 100 = 20% The price of back rubs has stayed the same. Inflation Rate: -The percentage of change in the CPI -Usually calculated over a year (the annual inflation rate). IR calculated between any 2 years… e.g. ((P2-P1)/P1) x 100 CPI in Jan 1995 = 131.9 CPI in Jan 1996 = 135.2 What is the percentage change in the CPI from 1995 -1996? = ((135.2 – 131.9) / 131.9) x 100 = (3.3/131.9) x 100 = 0.025 x 100 =2.50 Price level rose 2.5% between January 1995 and January 1996. The inflation rate is 2.5%. Effects of Inflation: - The dollar is the financial yardstick  Purchasing power of the dollar changes with inflation -[M/P] where M= Nominal Dollar and P= Price Level  i.e. The real value of the dollar changes with inflation -Inflation changes value of any sum that is fixed in NOMINAL terms [M]. Fully Anticipated Inflation: -If included in all financial contracts, inflation has no real effects Unanticipated Inflation: -Benefits those with an obligation to pay money (borrowers). -Harms those who are entitled
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