Inflation Key Terms and Concepts

Mar 2, 2025

Chapter 22: Key Terms - Principles of Economics 3e

Overview

Chapter 22 covers essential key terms associated with inflation and its measurement in economic systems. The terminology is crucial for understanding how inflation impacts the economy and how it is tracked and managed.

Key Terms Explained

Adjustable-Rate Mortgage (ARM)

  • Definition: A loan used to purchase a home where the interest rate varies with market interest rates.

Base Year

  • Concept: An arbitrary year set to an index value of 100. Inflation comparisons are made by looking at index numbers across different years in relation to the base year.

Basket of Goods and Services

  • Use: Represents a typical set of consumer purchases. Used to calculate changes in the price level over time.

Consumer Price Index (CPI)

  • Measure: Calculated based on the price level from a fixed basket of goods and services, representing the average consumer's purchases.

Core Inflation Index

  • Purpose: Derived from the CPI, excluding volatile items like food and energy to measure long-term price trends more accurately.

Cost-of-Living Adjustments (COLAs)

  • Function: A provision ensuring that wage increases align with inflation.

Deflation

  • Definition: Negative inflation, where most prices in the economy are falling.

Employment Cost Index

  • Focus: Measures inflation based on wages in the labor market.

GDP Deflator

  • Measure: Inflation based on prices of all GDP components.

Hyperinflation

  • Scenario: Extremely high inflation, often during transitions to market-oriented economies.

Index Number

  • Utility: Unit-free number helping to easily compute inflation rates, generally around 100.

Indexed

  • Mechanism: Automatic adjustment of prices, wages, or interest rates for inflation.

Inflation

  • Description: A broad and ongoing rise in price levels within an economy.

International Price Index

  • Measure: Based on the prices of merchandise that is exported or imported.

Producer Price Index (PPI)

  • Measure: Focuses on prices paid for supplies and inputs by producers of goods and services.

Quality/New Goods Bias

  • Issue: Fixed basket calculations can overstate living cost rises by ignoring quality improvements or new products.

Substitution Bias

  • Concern: Inflation rates using fixed baskets may overstate costs by not considering consumer substitution towards cheaper alternatives when prices rise.