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Price Indices and Inflation

Jackson Hernandez

Jackson Hernandez

9 min read

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Study Guide Overview

This study guide covers inflation, deflation, disinflation, and how to measure them using price indices like the Consumer Price Index (CPI). It explains how to calculate CPI and the inflation rate, discusses biases like substitution bias, and connects these concepts to real-world economic impacts. It also includes practice multiple-choice and free-response questions with answers.

AP Macroeconomics: Inflation & Price Indices - The Night Before 🚀

Hey! Let's get you prepped and confident for your AP Macro exam. We're going to break down inflation and price indices, making sure you've got this! 💪

Key Vocabulary

Before diving in, let's nail down some crucial terms:

  • Consumer Price Index (CPI): Measures the average price changes of a basket of consumer goods and services, like food, transport, and healthcare. It's like tracking the cost of your typical shopping list. 🛒
  • Inflation: A general increase in prices across an economy over time. Think of your favorite candy bar getting more expensive. 📈
  • Deflation: A general decrease in prices across an economy over time. Imagine everything going on sale! 📉
  • Disinflation: A slowing down in the rate of inflation. Prices are still rising, but not as quickly. 🐌
  • Inflation Rate: The percentage change in the overall price level of an economy within a year. It's the speed at which prices are changing. 🏎️
  • Real Variables: Economic values adjusted to remove the effects of inflation. It's like seeing the 'true' value, not just the inflated one. 👓

Understanding Inflation

Key Concept

Inflation, deflation, and disinflation are all about how prices change over time.

Inflation is when prices go up, deflation is when they go down, and disinflation is when inflation slows down. Central banks aim for a sweet spot, usually around 2% inflation, to keep the economy healthy. Too much or too little can cause problems. 🎯

  • Inflation is when the general level of prices in an economy is rising. It's expressed as a percentage and represents the rate at which the general price level is increasing over time. For example, if the inflation rate is 3%, it means that the general level of prices in the economy is increasing at a rate of 3% per year. 📈

  • Deflation is the opposite of inflation and occurs when the general level of prices in an economy is falling. Deflation is expressed as a negative percentage and represents the rate at which the general price level is decreasing over time. 📉

  • Disinflation is a slower rate of inflation, or a slowing down of the rate at which the general price level is increasing. For example, if the inflation rate was previously 5% and it slows down to 3%, it would be considered disinflation. 🐌

Here's a look at the US inflation rate over time. Notice how recessions usually bring lower inflation, except for the 1970s when we had stagflation (high inflation + slow economy) due to oil crises. ⛽

![Inflation Rate Over Time](https://zupay.blob.core.windows.net/resources/files/0baca4f69800419293b4c75aa2870acd_326c58_182.png...