The CPI measures the cost of a fixed basket of goods and services in a given year relative to the base year.

The inflation rate is determined by calculating the percentage change in a price index, such as CPI or the GDP deflator.

Real variables, such as real wages, are the nominal variables deflated by the price level.

The CPI as a measure of inflation has some shortcomings, such as substitution bias, causing it to overstate the true inflation rate.

Unexpected inflation arbitrarily redistributes wealth from one group of individuals to another group, such as lenders to borrowers.

Nominal GDP is a measure of how much is spent on output. Real GDP is a measure of how much is produced.

Nominal GDP measures aggregate output using current prices. Real GDP measures aggregate output using constant prices, thus removing the effect of changes in the overall price level.

One way of measuring real GDP is to weigh final goods and services by their prices in a base year. Because this can lead to overstatement of real GDP growth, statistical agencies actually use different methods.

Nominal GDP can be converted to real GDP by using the GDP deflator.

Business cycles are fluctuations in aggregate output and employment because of changes in aggregate supply and/or aggregate demand.

The phases of a business cycle are recession and expansion.

The turning points of a business cycle are peak and trough.

The difference between actual output and potential output is the output gap.

Potential output is also called full-employment output. It is the level of GDP where unemployment is equal to the natural rate of unemployment. [See EK MEA-1.E.2]

Explain how price indices can be used to calculate the inflation rate and to compare nominal variables over time periods.

Calculate the CPI, the inflation rate, and changes in real variables.

Define the shortcomings of the CPI as a true measure of inflation.

Explain the costs that unexpected inflation (deflation) imposes on individuals and the economy.

Define (using graphs and data as appropriate) turning points and phases of the business cycle.

Explain (using graphs and data as appropriate) turning points and phases of the business cycle.

Define nominal GDP and real GDP.

Calculate real GDP and the GDP deflator.