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And the measurement of inflation Definition = Measured by the CPI (?? ?? ??) - to measure inflation, subtract last year’s price index from this year’s price index and divide that number by last year’s price index, then multiply by 100 to express as a percentage Click here! Rate of Inflation = (Price Index Y2 – Price Index Y1) x100 Price Index Y1 So for instance if the Price Index for 2012 was 207.3 and the Price Index for 2011 was 201.6, what is the rate of inflation? 2.8% Really a “market basket” of 300+ consumer goods and services which are purchased by a typical “urban” consumer. Last class we discussed the GDP price index. What do you think was included in this measurement of economic growth? Let’s take a look at a CPI calculator which will allow us to compare the prices of consumer goods and services of various consumer goods. CPI Calculator Divide 70 by the percentage rate of inflation = approximate number of years for the price level to double Ex: at 7% annual inflation = 10 years for prices to double Deflation (definition??) is as much of a potential problem as inflation • All nations experience inflation and/or deflation • Some nations experiences astronomical rates of inflation • EX: Zimbabwe’s rate of inflation in 2005 was 585%!!! 1.“Demand-pull” inflation 2.“Cost-push” inflation • • Spending increases faster than production “Too much money chasing too few goods” • • • • Also known as “supply side” inflation Prices rise because of a rise in per-unit production costs • Or unit cost = total input costs/units of production Output and employment decline while the price level is rising Supply shocks have been a major source of cost-push inflation, typically due to dramatic increases in the price of raw materials or energy • EX: Oil embargoes of the early 1970s caused cost-push inflation Nominal vs. real income • • Nominal = Real = •Real income = nominal income ÷ CPI (in hundredths) •CPI used to deflate nominal income into real income If one can “anticipate” the rate of inflation, one can take some steps to adjust for inflation to lessen its effects If inflation is going to go up, you will buy goods and services now rather than save money If inflation is going to go done, you will like save your money and buy goods and services when prices go down However most inflation occurs without most people “anticipating” it correctly! Real interest = Nominal interest = EX: New Home Mortgage Nominal IR = 5%, Inflation = 1.5%, so Real IR = 3.5% Workers participating in the labor and product markets 1. A. “Sticky Wages” Fixed Income Receivers A.People living on Social Security or fixed pension payments 3. Savers A.Savings loses its purchasing power 4. Creditors A.Repayments worth less in purchasing power 2. Flexible income receivers A.Cost of living adjustments (COLAs) help to offset inflation 2. Debtors A.Paying back with “cheaper” dollars 1. Many families are simultaneously helped and hurt by inflation as they are borrowers as well as earners and savers A. B. C. D. Cost push inflation could cause both output and unemployment to decline; therefore REAL INCOME declines Demand-pull inflation can reduce real output because inflation diverts time and effort toward activities designed to hedge against inflation Mild inflation (< 3%) may be a healthy result of a prosperous economy or have an undesirable effect on real income – ONLY TIME CAN TELL! Creeping inflation can lead to hyperinflation as people speculate the inflation rate, begin to spend recklessly on anticipated price increase, thus producing more inflation