Macroeconomists define inflation/deflation in multiple ways. Please begin by giving us the definitions in terms of the consumer price index (CPI), the producer price index (PPI) and the GDP deflator.
a) From the point of view of the average standard of living of U.S. citizens, why is the CPI the best measure of inflation/deflation?
b) Nonetheless, with reference to an economy with just two commodities, chicken and beef, explain why “substitution effects” mean that the CPI can be misleading. In this two-commodity economy, suppose that, between year 1 and year 2, there is a shift to the right in the supply curve for chicken and a shift to the left in the supply curve for beef, holding everything else (e.g., the demand curves for chicken and beef) constant.
c) With reference to the following data about a two-commodity economy, explain how macroeconomists calculate the GDP deflator, thereby solving the problem that substitution effects pose for our efforts to measure the effects of inflation/deflation on the average standard of living.
2009 nominal GDP 2018 nominal GDP
Bananas 15 at $0.20 20 at $0.30
Oranges 50 at $0.22 60 at $0.25
d) What patterns can be discerned in the data on inflation/deflation since World War II? In particular, please identify business-cycle peaks, business-cycle troughs, recessions, economic expansions, and trend rates of change during the Golden Age of U.S. economic development (1950-1973), the Neoliberal Era (1982-2007), and since the 2007-08 financial crisis.
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