Question

Inflation in-class assignment 1. Explain how an increase in your nominal income and a decrease in your Income might occur simultaneously. What effects does inflation have on the purchasing power of the dollar? 2. What is the CPI and how is it determined each month? Show how the BLS calculates the inflation rate from one year to the next. 3. Explain the difference between nominal and real interest rates How are creditors and debtors affected during inflation? Give an example. 4. How does deflation differ from inflation? 5. Explain how hyperinflation might lead to a severe decline in total output. 6. Distinguish between demand-pull and cost-push inflation. Which of the two types is associated with negative GDP gap? Associated with Positive GDP gap.

Answer 1

1) Nominal income is income unadjusted for the effects of inflation or deflation. Hence, after including the effect of inflation, the increase in nominal income may occur simultaneously with decrease in income.

Inflation reduces the purchasing power of dollar

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2) A consumer price index (CPI) is an estimate as to the price level of consumer goods and services in an economy which is used as a way to estimate changes in prices and inflation. A CPI takes a certain basket of common goods and services, for instance a gallon of gas, a loaf of bread and a haircut, and tracks the changes in the prices that basket of goods over time.

Calulation:

Current item price ($) = (base year price) * [(Current CPI) / (Base year CPI)]

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3) Nominal interest rate is the rate which does not account for inflation while real interest rate is the rate which accounts for inflation.

Infaltion negatively affetcs the creditors as the value of money decreases while it positively affects the debtors

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4) Inflation is the reduction in value of money due to increase in its supply while Deflation occurs when the inflation rate falls below 0% (a negative inflation rate) The overall price level decreases so that inflation rate becomes negative.

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5) In hyperinflation prices get hit by a triple whammy due to the increase in the money supply, the increase in the velocity of money and thedecrease in production.

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6) Demand-pull inflation is a term used to describe when prices rise because the aggregate demand in an economy is greater than the aggregate supply while Cost-push inflation is a type of inflation caused by substantial increases in the cost of importantgoods or services where no suitable alternative is available.

Cost-push inflation is most likely to be associated with a negative GDP gap