160 Putting It Together: Inflation and Price Indexes

Summary

The goal of this module was to teach you how to use economic indicators to assess the state of the economy. You learned how to:

• Define the rate of inflation; Explain how the rate of inflation is calculated
• Identify the consequences of price instability (i.e. inflation)
• Explain the concept of a price index and explain how price indices are derived.
• Use a price index to translate between real and nominal data
• Define the GDP price index (also known as the GDP deflator or the Implicit Price Deflator)
• Differentiate between nominal GDP and real GDP

Examples

Let’s return to the questions posed in the Why it Matters feature. This module explained that the economy goes through cycles of speeding up and slowing down. Recession doesn’t just mean a slowdown in the economy (a decrease in economic growth), but rather negative economic growth, a decrease in real GDP over at least six months, so that the economy is actually producing less goods and services than in did before. Recessions happen on average about once every five years, and they tend to average one year of recession and four years of expansion. The measured unemployment rate never gets to zero, because of frictional unemployment, the time it takes for employers and job seekers to find each other. The economy is close to full employment when the measured rate reaches perhaps five percent. The U.S. economy has not experienced significant inflation since the early 1980s. Using what you’ve learned, you should be able to judge the current state of the economy. Here is one judgment from 2014:

Now that you know the most important economic indicators, the rest of this text will explain what causes them to do what they do and how they are related to one another.