Chapter 6. Inflation
QUESTIONS AND PROBLEMS
QUESTIONS
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- How do economists use a basket of goods and services to measure the price level?
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Why do economists use index numbers to measure the price level rather than dollar value of goods?
- 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?
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Why is the GDP deflator not an accurate measure of inflation as it impacts a household?
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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?
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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.
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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.
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Over the last century, during what periods was the U.S. inflation rate highest and lowest?
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Within 1 or 2 percentage points, what has the U.S. inflation rate been during the last 20 years? Draw a graph to show the data
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What is deflation?
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Identify several parties likely to be helped and hurt by inflation.
- What is indexing? Name several forms of indexing in the private and public sector.
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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, is five the inflation rate each year? Is the inflation rate the same each year? Explain your answer.
- 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. Then based on the nominal interest rates, inflation rates and real interest rate in the table below, in which of the years would it have been best to be a lender? Based on the nominal interest rates, inflation rates and real interest rate in the table below, in which of the years given 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% |
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. In which years would it have been better to be a person borrowing money from a bank to buy a home? In which years would it have been better to be a bank lending money?
| Year | Mortgage Interest Rate | Inflation Rate |
| 1984 | 12.4% | 4.3% |
| 1990 | 10% | 5.4% |
| 2001 | 7.0% | 2.8% |
16. If inflation rises unexpectedly by 6%, indicate for each of the following whether the economic actor is helped, hurt, or unaffected:
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- A union member with a COLA wage contract
- Someone with a large stash of cash in a safe deposit box
- A bank lending money at a fixed rate of interest
- A person who is not due to receive a pay raise for another 11 months
