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Video transcript

when economists refer to inflation today they are referring to a general increase in the level of prices of goods and services so they're really talking about price inflation the reason why I stress that is because sometimes right especially when the term inflation first came into usage it actually was referring to monetary inflation or an increase in the money supply so it was referring to an increase in the money supply these two ideas are closely related but it's important to realize that people really are measuring inflation they're talking when they're talking about inflation today they're talking about price inflation because although these two things are related they aren't always exactly the same thing it is generally true that if the money supply and the money supply is more than just the amount of dollars that are printed is the amount of dollars that are printed it's affected by the amount of lending that's occurring it's amount it's affected by the number of transactions that are occurring in the economy and if that money supply that's affected by all of those things grows faster than the total real productivity of the economy then it will generally increase the level of prices but especially in the short term there could be other causes of price inflation you could have things like supply shocks and a supply shock is the supply of something become scarce all of a sudden the most typical example of a supply shock is is especially in the oil crises in the 1970s if for whatever reason oil becomes scarce in a country like the United States then the price of oil and gas would go up oil and gas would go up but then these are inputs into a whole set of things even that banana that you buy the grocery store if the price of oil or gas or both of them frankly were the price of oil were to shoot up even the price of your banana would shoot up because to get that banana to your store you need to use some gasoline in fact a significant fraction of that banana in that store was probably the cost of the gasoline to offer that ship - take that - take that banana from wherever it was grown to your grocery store and then on a railroad and then on a truck or whatever so this would affect the general prices not just the prices of oil or gas so these two things are related but it's important to realize is that moat that people are referring to price inflation and the general consensus is a little bit of it is a good thing so a little is good a little and I want to stress little is good and we're talking one two maybe three percent per year and but anything larger than that gets a little scary because it can kind of snowball on itself and we'll talk about that in future videos when we talk about hyperinflation and economists are also afraid of inflation to where it ever get negative that leads to deflation and we'll talk in future videos why in many circles that is viewed as a as a scary thing now in the United States this inflation is measured with the Consumer Price Index CPI you'll always hear this reported in the news especially if you watch some of the business programming and there are actually multiple consumer price indices the one that people report whenever they say the CPI went up 2% they're actually refract they are actually referring to the CPI - you and the you here stands for urban urban consumers and the reason why this is the headline CPI CPI are the one that people actually report is because most of the country in the United States they are urban consumers so this is the CPI that affects the largest number of people's pocketbooks and the way that it's the way that it's calculated is it's like the deflator it's a price index and like the deflator or it's measuring a general increase or a general change in the level of prices but they actually are calculated in slightly different ways although they they should come into agreement if they really arm it or they should be close to each other if they really are indices for measuring the general level of prices but the way that the CPI works is that they pick a basket of good for this type of consumer and a base here so they'll pick up base here and let's take a super simple example a ridiculously simple example of let's say in our little country the consumer the urban consumer so we'll focus on CPI - you only consumes two things and the next video we'll see that in reality we consume any more than two things but the two things and they spend 60% of their money on apples on Apple's and they spend 40% of their money on bananas bananas and in that base year we just set that base price of apples at 100 and that bananas are 100 now we're not saying that apples and bananas cost the same thing we're saying that we're spending 60% of our money on Apple's 40% on bananas in that base year and that this is just that base year level of prices what will matter is how much this grew what will this index change as we go to whatever year we want to calculate the inflation in relative to this base year so let's say in our current year could be the very next year so let's say in our current year and we're going to assume these same weights that we're still spending 60% on apples and 40% on bananas and our current year the Apple index let's say that it has grown it has grown 50 percent to 150 so it is plus 50% and let's say that the banana index has grown to 180 so bananas have gotten even more expensive plus 80 percent so how would we measure what would we say how much would we say the CPI - you has grown well we would take an a weighted average of these indices or you could say a weighted average of the growth and you could do it either way so let's do it either way to get you the same result so in this year our base index is 0.6 times 100 0.6 times 100 plus 0.4 times 100 plus 0.4 times 100 and this will just come out to 100 this is 60 plus 40 this is equal to 100 as it should that is our base year that is our base for our index now over here in our current year so this is what we're transitioning to there's a couple of ways to do it you could say look we're spending 60% on something that has gone up to 150 now so we'd say 0.6 times times 150 and then we'll say plus 0.4 times 180 and that gets us to let me get my calculator out so this gets us point six times 150 plus plus 0.4 times one and 80 so that gets us to 162 162 so our general if you look at this basket and this is an overly simplified basket we have increased we have increased from 100 from 100 to 160 - or you could say this is plus 62% and you would have gotten the same result if you took the weighted average of the percentages if you took 0.6 times 50% plus 0.4 times 80% in fact we could do that in our head 0.6 times 50% is going to be 30 percent and then 0.4 times 80% is going to be 32 percent 30 plus 32 gives us 62 percent growth if for this basket of goods which we're assuming is I guess for this urban consumer from our base here through the current here now in the next video we'll actually look at what the basket of goods actually looks like in the United States for an actual urban consumer