Chapter 6. Inflation

# QUESTIONS AND PROBLEMS

QUESTIONS

1. How do economists use a basket of goods and services to measure the price level?
2. Why do economists use index numbers to measure the price level rather than dollar value of goods?
3. Inflation rates, like most statistics, are imperfect measures. Can you identify some ways that the inflation rate for fruit does not perfectly capture the rising price of fruit?
4. Why is the GDP deflator not an accurate measure of inflation as it impacts a household?
5. Imagine that the government statisticians who calculate the inflation rate have been updating the basic basket of goods once every 10 years, but now they decide to update it every five years. How will this change affect the amount of substitution bias and quality/new goods bias?
6. Describe a situation, either a government policy situation, an economic problem, or a private sector situation, where using the CPI to convert from nominal to real would be more appropriate than using the GDP deflator.
7. Describe a situation, either a government policy situation, an economic problem, or a private sector situation, where using the GDP deflator to convert from nominal to real would be more appropriate than using the CPI.
8. Over the last century, during what time periods was the U.S. inflation rate highest and when was it the lowest?
9. Create a table stating the U.S. inflation rate over the last 50 years then draw a time series graph to show your data. Or use the FRED website to create and download the table and chart.
10. What is deflation?
11. Identify several parties likely to be helped and hurt by inflation.
12. What is indexing?  Name several forms of indexing in the private and public sector.
13. The index number representing the price level changes from 110 to 115 in one year, and then from 115 to 120 the next year. Since the index number increases by five each year, does that mean the inflation rate 5% each year?  Explain your answer.
14. The “prime” interest rate is the rate that banks charge their best customers. Use the data provided to calculate the Real Rate of Interest in each year, add a new column to the table showing the Real Rate of Interest. Then based on the nominal interest rates, inflation rates and real interest rate in the table below, indicate which years would have been best to be a lender and which years would it have been best to be a borrower?
 Year Prime Interest Rate Inflation Rate 1970 7.9% 5.7% 1980 15.27% 12.5% 1984 12.04% 3.9% 1990 10.1% 6.1% 2000 9.23% 3.4% 2009 3.25% -0.4% 2020 3.25% 1.25% 2022 4.85% 8.0%

15. A mortgage loan is a loan that a person makes to purchase a house the table below provides a list of the mortgage interest rate for several different years and the rate of inflation for each of those years. Add a column to the table and calculate the Real Rate of Interest for each year.  Then for each year indicate whether it would be better to be a someone borrowing the money for a home loan, or the institution that is lending the money for the home loan.

 Year Mortgage Interest Rate Inflation Rate 1984 12.4% 4.3% 1990 10% 5.4% 2001 7.0% 2.8% 2022 4.85% 8.0%

16. If inflation rises unexpectedly by 6%, indicate for each of the following whether the economic actor is helped, hurt, or unaffected:

1. A union member with a COLA wage contract
2. Someone with a large stash of cash in a safe deposit box
3. A bank lending money at a fixed rate of interest
4. A person who is not due to receive a pay raise for another 11 months