Inflation Formula with Adaptive Expectations
Inflation, defined as the percentage increase in prices, is equivalent to the rise in costs per unit of output. Assuming wages are the only cost, inflation equals the percentage increase in wages. This wage increase is composed of two parts: the expected inflation rate and the bargaining gap. When expectations are adaptive, meaning people expect this period's inflation to be the same as last period's, the formula becomes: . Here, is the inflation rate in the current period, is the inflation rate from the previous period, and is the bargaining gap in the current period.
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