Demand-Pull inflation

Cost-Push inflation

Nominal income= Real income + Inflation Premium

Ex. .10= r + .06

.04= r

• your nominal return is the percentage change in the amount of money you have
• your real return is the percentage change in the amount of stuff you can buy

defines the relationship between real rates, nominal rates, and inflation

Formula: (1+R)=(1+r)(1+h)

R=nominal rate

r=real rate

h=expected inflation rate

1. Fixed Nominal-Income Receivers
2. Savers
3. Debitors and Creditors (unanticipated inflation benefits debtors at the expense of creditors)

Formula: Amount in today's dollars= Amount in year T's dollars [price level of today/price level in year T]

Babe Ruth Salary Example

• The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a typical consumer
• The Bureau of Labor Statistics (BLS) reports the CPI each month
• It is used to moniter changes in the cost of living over time
• When CPI rises, the typical family has to spend more dollars to maintain the same standard of living

• The GDP Deflator [(Nominal GDP/Real GDP) * 100] reflects the prices of all goods and servcies produced domestically
• The consumer price index reflects the prices of all goods and services bought by consumers

1. Fix the basket. Determine what prices are most important to the typical consumer.
2. Find the prices
3. Compute the basket's cost
4. Choose a base year and compute the index
5. Compute the inflation rate

CPI= [(price of basket of goods and services/price of basket in the base year) * 100]

Inflation Rate in Year 2=

[(CPI in Year 2 - CPI in Year 1/ CPI in Year 1) * 100]

• The substitution bias, introduction of new goods, and unmeasured quality changes cause the CPI to overstate the true cost of living
• The CPI overstates inflation by about 1 percentage point per year

• Consists of the group of institutions in the economy that help to match one person's saving with anoth person's investment
• It moves the economy's scarce resources from savers to borrowers

• The financial system is made up of financial institutions that coordinate the actions of savers and borrowers
• Financial Institutions can be grouped into two different categories: Financial Markets (Stock and Bond Markets) and Financial Intermediaries (Banks and Mutual Funds)

The institutions through which savers can directly provide funds to borrowers

ex. Stock markets and Bond Markets

Insititutions through which savers can indirectly provide funds to borrowers

ex. Banks and Mutual Funds

• Term: the length of time until the bond matures
• Credit Risk: the probability that the borrower will fail to pay some of the interest or principal
• Tax Treatment: the way in which the tax laws treat the interest on the bond. (Municipal bonds are federal tax exempt)

• Stock represents a claim to partial ownership in a firm and is therefore, a claim to the profits that the firm makes.
• The sale of stock to raise money is called equity financing

• A mutual fund is an institution that sells shares to the public and uses the proceeds to buy a portfolio, or various types of stocks, bonds, or both.
• Mutual Funds allow people with small amounts of money to easily diversify.

• Credit Unions
• Pension Funds
• Insurance Companies
• Loan Sharks

• Y (National Income)-C (Capital Expenditure)-G (Government Expenditures) = I (Investments)
• Savings (S) can be substituted for Y-C-G now written as S=I
• National Saving is the total income in the economy that remains after paying for consumption and government purchases

• The amount of income that households have left after paying their taxes and paying for their consumption
• Formula (Y-T-C)

• The amount of tax revenue that government has left after paying for its spending
• Formula (T-G)

• If Taxes (T) > Government Expenditures (G), the government runs a budget surplus because it receives more money than it spends (The surplus of T-G represents public savings)
• If Taxes (T) < Government Expenditures (G), the government runs a budget deficit because it spends more money than it receives in tax revenue

• Financial markets coordinate the economy's saving and investment in the market for loanable funds
• The market for loanable funds is the market in which those who want to save supply funds and those who want to borrow to invest demand funds

• Policy 1: Taxes and Savings (Savings Incentives)
• Policy 2: Taxes and Investment (Investment Incentives)
• Policy 3: Government budget deficits and surpluses

• The amount of money in the future that an amount of money today will yield, given prevailing interest rates
• FV= PV (1+i)ⁿ

• the amount of money today that would be needed to produce, using prevailing interest rates, a given future amount of money.
• PV = FV/((1+i)ⁿ)

• According to the rule of 70, if some variables grow at a rate of X percent per year, then the variable doubles in approximately 70/X years

• Buy insurance
• Diversify
• Accept a lower return on their investments

• Diversification refers to the reduction of risk achieved by replacing a single risk with a large number of smaller unrelated risks.
• Firm-specific risk is risk that affects only a single company
• Market risk is risk that affects all companies in the stock market
• Diversification cannot remove market risk

• The higher the risk the greater the return. But potentially greater loss as well.

• Utility: common term for satisfaction
• As a person gains more wealth, the satisfaction from said wealth lessens

• the study of a company's accounting statements and future prospects to determine its value
• People can employ fundamental analysis to try to determine if a stock is undervalued, overvalued, or fairly valued
• The goal is to buy undervalued stock

• The theory that asset prices reflect all publicly available information about the value of an asset.
• A market is informationally efficient when it reflects all available information about the value of an asset in a rational way.

• A rising general level of prices in an economy
• It is measured by examining the general level of prices in a year relative to prices in a base year