4.7: inflation and demand

• Nominal variables are measured at current prices (without adjusting for inflation)
• real variables are adjusted to reflect the true value by accounting for inflation
• • Imagine everything in the economy doubles in price: goods, wages, rents, dividends—all increase by 100%.
  • In this case, what you could afford before inflation, you can still afford afterward because both prices and incomes double proportionally.
  • Result: Demand behavior does not change since the relative costs of goods remain the same.
• The key takeaway is that demand is unaltered when both prices and incomes rise at the same rate across the economy. This is because the relative purchasing power of consumers stays the sa
• Own-price elasticities measure how the quantity demanded changes when the price of a good changes, holding other factors constant (like incomes and the prices of related goods).
• during inflation, when all prices and incomes are changing at the same time, this complicates the measurement of elasticities.
• When prices and incomes are all rising proportionally, the change in quantity demanded can be split into three parts:

  1. The effect of changes in own-price (price of the good itself).
  2. The effect of changes in the prices of other goods (cross-price effects).
  3. The effect of changes in income.