Who Is Making More?

1
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?

2
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?
• Lets find out the Consumer Price Index (CPI).

3
Who Is Making More?

• According to Bureau of Labor Statistics
  (ftp//ftp.bls.gov/pub/special.requests/cpi/cpiai.
  txt), 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.

4
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.

5
How To Calculate The CPI?

• Fix the basket a typical consumer will buy.
• Find the prices of the items for different years.
• Compute the baskets 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.

6
CPI Calculation
7
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.

8
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?

9
Real Median Household Income
10
http//www.census.gov/acs/www/Products/Profiles/Ch
g/2003/ACS/Tabular/010/01000US3.htm
11
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.

12
Indexation

• If payments are automatically corrected for
  inflation, they are said to be indexed.
• COLA
• Social Security
• TIPS
• Variable mortgage rates

13
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

14
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?

15
Costs of Inflation

• Distortions of the tax system
• Depreciation allowance and the replacement cost
• Bracket creep

16
Costs of Inflation

• Unexpected distribution of wealth
• Real wage down gt workers lose, employers gain
• Borrowers gain and creditors lose

17
Costs of Inflation

• Interference with long-run planning
• Increase uncertainty
• Impossible to predict the future

18
Hyperinflation

• Inflation of 500 or more per cent per year.
• Germany in early twenties.
• Argentina and currency board.

19
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?

20
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 p

21
Real and Nominal Interest Rates