Transcript Who Is Making More?

Who Is Making More?
• A 2001 graduate of Hiram College got a job
that pays $30,000 per year.
• Thirty years ago, her father started his
career with a $7,500 job.
• Is she making four times as much as her
father did?
Who Is Making More?
• In order to compare the incomes of two
different periods we have to eliminate the
effect of inflation.
• What happened to prices between 1969 and
2001?
• Let’s find out the Consumer Price Index
(CPI).
Who Is Making More?
• According to Bureau of Labor Statistics
(ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.t
xt), CPI in 1969 was 36.7.
• CPI in 2001 was 177.5. Base year was 1982-84.
• If the average price level in 1969 was lower
than in 2001, our graduate must not have been
three times better off.
Who Is Making More?
• In real terms:
– She made (30,000/1.775) = $16,901.41 in 1983
dollars.
– He made (7,500/.367) = $20,436 in 1983
dollars.
• How much was his pay in 2001 dollars?
– His pay is (7,500)(1.775/.367) = $36273.84.
How To Calculate The CPI?
• Fix the basket a typical consumer will buy.
• Find the prices of the items for different
years.
• Compute the basket’s cost for each year.
• Choose a base year.
• Calculate the cost of the basket for other
years in terms of the base year.
• Calculate inflation rates.
CPI Calculation
Consumer Basket is 2 Pizzas and 10 Sodas
Year Pizza Price Soda Price Pizza Spending Soda Spending Total Spending CPI (base=1999) Inflation
1996 $10.00 $0.75
$20.00
$7.50
$27.50
82.09
1997 $10.50 $0.85
$21.00
$8.50
$29.50
88.06 7.27%
1998 $10.75 $1.00
$21.50
$10.00
$31.50
94.03 6.78%
1999 $11.50 $1.05
$23.00
$10.50
$33.50
100.00 6.35%
Problems With CPI
•Substitution bias.
–Basket changes as a response to relative price changes do
not get accounted.
•New products.
–Basket changes are ignored.
–Prices of new products fall before they are included in the
new basket.
•Quality change.
–If the same gadget has higher quality now than in the past
but viewed as the same item, an increase in price is not
inflationary.
Median Household Income

According to the US Census Bureau,
nominal income for a family of four was
$24,332 in 1980. In 1997, it was $53,350.
 CPI in 1980 was 82.4; in 1997, 160.5.
 What happened to median real income?
 How would you change your answer if
Boskin Commission is right?
Real Median Household Income
Years Nominal Income
1980
$24,332.00
1985
$32,777.00
1990
$41,451.00
1997
$53,350.00
CPI Real Income Growth Rate
82.4 $29,529.13
107.6 $30,461.90
3.16%
130.7 $31,714.61
4.11%
160.5 $33,239.88
4.81%
http://www.census.gov/acs/www/Products/Profiles/Chg/2003/ACS/Tabular/010/01000US3.htm
GDP Deflator vs. CPI
• Space shuttle costs more to operate.
– Deflator is up, CPI unchanged.
• Antiques cost more.
– CPI is up, deflator unchanged.
• Porsche increases the price.
– CPI is up, deflator unchanged.
• New homes cost more.
– Both CPI and deflator up.
Indexation
• If payments are automatically corrected for
inflation, they are said to be indexed.
–
–
–
–
COLA
Social Security
TIPS
Variable mortgage rates
Costs of Inflation

Shoe-leather costs
– Economizing on cash
– More frequent trips to the bank
– More bank employees
– Efforts to avoid the erosion of purchasing
power
Costs of Inflation

Noise in the price system
– Is it an increase in the demand for a product or
is it a general increase in prices?
– Should the supplier increase output or not?
Costs of Inflation

Distortions of the tax system
– Depreciation allowance and the replacement
cost
– Bracket creep
Costs of Inflation

Unexpected distribution of wealth
– Real wage down => workers lose, employers
gain
– Borrowers gain and creditors lose
Costs of Inflation

Interference with long-run planning
– Increase uncertainty
– Impossible to predict the future
Hyperinflation

Inflation of 500 or more per cent per year.
 Germany in early twenties.
 Argentina and currency board.
Real and Nominal Interest Rates
• If you lend someone $1000 for a year and
ask for a 5% interest, you will get $1050 at
the end of the year.
• If inflation during the year were 10%, the
products you could buy with your $1000 at
the beginning of the year now costs $1100.
• Are you better-off or worse-off?
Real and Nominal Interest Rates
• Lenders will always ask a higher interest
rate than the expected inflation to earn
income.
• Nominal interest rates are what the bank
quotes, what the car dealer quotes.
• Real interest rates are nominal rates
corrected for inflation.
• i=r+π
Real and Nominal Interest Rates