[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

20
15
RATE OF INFLATION IN CPI (%)
10
5
0
–5
–10
–15
1920 1930 1940 1950 1960 1970 1980 1990 2000
Figure 28.2
THE RATE OF INFLATION
Inflation has fluctuated considerably over the past ninety years. It reached significant
levels during World War I, World War II, and the Korean War, and was negative (i.e.,
prices fell) during most of the period between the two world wars. The period from the
late 1960s until the early 1980s is sometimes described as the Great Inflation, because it
represented an extended period of high inflation not associated with wartime.
SOURCE: Bureau of Labor Statistics.
the prices of all the goods and services that the economy produces as part of GDP.
The CPI measures the prices of things purchased by households. In 2004, the CPI
was equal to 189. This means that in 2004 it took $1.89 to purchase what could have
been bought for $1.00 in the index base year (an average of prices in 1982–1984).
Because the price level tells us how much it costs to purchase goods and services,
it is a measure of the value of money. If the price level rises, each dollar will
buy fewer goods and services: the value of money falls. If the price level falls, each
dollar will buy more goods and services: the value of money rises.
The value of money, like the value of other commodities, is determined by the
interaction of demand and supply. To understand what determines the price level,
we will need to examine the factors that affect the demand for and supply of money.
PRICE LEVEL (P)
MONEY DEMAND
Money is a financial asset, just like stocks and bonds. But money differs from those
other assets because we use it to carry out our day-to-day transactions. If you want
to buy a cup of coffee, you cannot present the sales clerk with a share of Microsoft
Corporation and expect change. In the United States, you have to present cash. Or
you can pay with a credit card—but to pay for those credit purchases, you need to
write a check at the end of the month. Cash and balances in checking accounts are
the primary forms of money that we use. The more transactions we engage in, or
the higher the average value of these transactions, the more of those forms of money
Figure 28.3
Y f
OUTPUT (Y )
POTENTIAL GDP AND THE
AGGREGATE PRICE LEVEL
The economy’s potential GDP does not
depend on the price level; this is represented
by drawing a vertical line at
potential GDP.
PRICES AND INFLATION ∂ 607