Wednesday

 Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 8 The Data of Macroeconomics
Chapter 24 of 36 Measuring The Cost of Living
Section 2 of 15
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In 1931 the U.S. economy was in the Great Depression and the New York Yankees paid Babe Ruth an $80,000 salary.
This pay was extraordinary for the time, even among baseball stars.
In 2007 shortstop Alex Rodriguez earned $28 million and the median salary earned by a New York Yankees player was $4.8 million.
This might make one think baseball has become hugely more lucrative over the past seventy years.
But as we know the prices of goods have also risen.
In 1931 a nickel would buy an ice-cream cone, and a quarter would buy a ticket at the local movie theater.
Because prices were much lower in Babe Ruth's day, it’s not clear whether Ruth had a higher value salary than today's players.
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Babe Ruth earned $80,000 with the Yankees in 1931. What would the equivalent today be?
Gemini:
To find the equivalent value, we compare the 1931 average CPI (approximately 15.2) to the current January 2026 CPI (325.25).
2026 Equivalent: ~$1,711,853
If Ruth were paid the same share of baseball's total revenue today as he was then, his salary would be close to $100 million a year.
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This chapter we look at how economists measure the cost of living.
To compare previous prices to prices today we must find a way of turning dollar figures into meaningful purchasing power measures.
This is the purpose of a statistic called the consumer price index (CPI).
After seeing how the CPI is constructed we’ll look at how to use the CPI to compare dollar figures from different times.
When the CPI rises a family must spend more money to maintain the same standard of living.
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Economists use the term inflation for a situation when the overall price level is rising.
The inflation rate is this period’s percentage change in the price level from the previous period.
CPI reflects consumer goods prices and is the most common inflation gauge.
Inflation is a key variable guiding macroeconomic policy.
Here we will look at the foundation for inflation analysis by considering
· how economists measure the inflation rate using CPI
· how CPI is used to compare dollar figures of different times
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Gemini: Between 1931 and 2025, the average yearly consumer price increase was approximately 3.30%.
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What yearly percent inflation rate do economists consider optimal?
Gemini:
Most economists and major central banks —like the Federal Reserve in the U.S., the European Central Bank, and the Bank of England— consider a 2% annual inflation rate to be the "sweet spot" for a healthy economy.
While it might seem counterintuitive —wouldn't 0% inflation be the best target?— a small, predictable amount of inflation serves as the "grease" for the economic engine.
Why 2%? The "Goldilocks" Zone
Central banks aim for 2% because it balances the risks of two extremes:
1. Why not 0% (or lower)?
The Deflation Trap: If prices stay the same or fall (deflation), people stop spending.
Why buy a car today if it will be cheaper in six months?
This leads to lower demand, business closures, and layoffs — the very cycle that made the 1931 Great Depression so devastating.
The "Zero Lower Bound": If inflation is at 0%, central banks have very little room to cut interest rates to stimulate the economy during a recession.
A 2% "buffer" allows them more flexibility.
2. Why not target a 5% or higher inflation rate?
Purchasing Power Erosion:
At 5%, prices double every 14 years.
This devalues incomes and people must continually push for wage increases, and hits people on fixed incomes, like retirees, particularly hard.
Economic Friction:
High inflation creates "menu costs" —businesses have to constantly update prices— and "shoe-leather costs," where people spend too much time and energy trying to protect their money from losing value.
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purchasing power
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