Eco 101, Davis, handout 12b, page 1

Handout 13: Inflation

I. Inflation
a. Def: A rise in the general level of prices  fall in the value of money
b. Measuring the price level: Consumer Price Index (CPI)
1. Basket of goods: 300 good purchased by a typical consumer
2. Base year = year used as a reference point for the price level.

3.

c. Measuring inflation: Inflation rate = % change in CPI =

d. Types of Inflation:
1. Demand Pull: D > S  “Too much money chasing too few goods”
2. Cost-Push: Supply side  input prices rise
 Eco 101, Davis, handout 12b, page 2

II. Real and Nominal Variables:

a. Real Income Levels
1. Nominal income = income measured in current dollars
2. Real income = income measured in constant (base year) dollars

real income =

3. Computing Dollar Values: Value today = Value(T)

Example: Dad earned $7000 in 1972. What’s it worth in 2005?

CPI(1972) = 41.8
CPI(2005) = 195
Salary in $2005 =

b. Real interest rates: real r = nom. r – inflation

III. Cost of Inflation

a. Who Is hurt/helped by inflation
1. Savers:
2. Income
3. Loans

b. On average:

c. Anticipated Inflation: Less harmful, built into contracts

1. Incomes:

2. Loans: