Download inflation unit

Dr. Evil is having difficulty
negotiating…
Inflation
“A period of rapidly rising prices”
The dollar’s value may be said to be
falling.
Demand - Pull
• Demand for goods &
services outraces
supply.
• Example: 1970’s US
auto makers stopped
producing convertibles.
In 1980- Mazda Miata
was introduced. The
MSRP was $12,000 but
dealers were selling
them for $15,000.
Causes
• Changes in spending
habits of individuals &
business firms
• Federal Government
spends more than it
earns in taxes & other
revenues.
• Psychological Expectation of inflation
Cost Push
• A run-up in prices
that results as sellers
raise their prices
because of an
increase in their
costs.
Causes
• Wage-price spiral
• Profit-push
Types of Inflation
• Creeping
• Chronic
• Hyperinflation
Inflation Rate
• CPI is used to measure
the inflation rate or how
much price level
increases each year.
Consumer Price Index
• A price index determined by measuring the
price of a standard measure of goods meant to
represent the typical “market basket” of a
urban consumer.
• The basket includes food items, air travel,
college tuition, electronic equipment, etc.
Price Index Y2 – Price Index Y1
X 100
Price Index Y1
Has the cost of going to the movies
really increased?
Price of a movie ticket in 1970 - $.25
CPI (base year 1990) – 38.3
Expressed in 1990 dollars - $.65
CPI (2014) – 222
1990 Price x 2014 CPI = 2014 Price
2014 Price - $1.44
Problems with CPI
1. Neglects quality
improvements
2. Neglects buyer
responses to changes in
relative prices.
3. Has failed to keep up
with the shift consumers
have made toward
discount outlets.
Impact of These Problems
Determines changes in an array of payments
Wage agreements that include a cost-of-living
(COLA) allowance
Cost of living adjustment: an automatic
increase in income when the inflation rate
increases.
Social Security benefits
Welfare payments
About 30% of federal outlays are tied to
changes in the CPI
Bad news for retirees: No Social Security costof-living increase, higher medical costs for many
• Officials say there will be no benefit increase next year for
millions of Social Security recipients, disabled veterans and
federal retirees. (AP)
• Tens of millions of seniors will see no annual cost-of-living
adjustment in their Social Security checks in 2016, the
government said Thursday, unwelcome news that also will
flatten benefit payments for retired federal workers and
service members.
• The raises are tied to the consumer price index (CPI), which
has been flat because of lower gasoline prices.
Inflation and Wages
1. Consumers and workers will experience a decline in
purchasing power
2. Real Income = Nominal Income
CPI x .01
Congratulations! You have received a $5,000 raise!
You have gone from making $65,000 last year to $70,000 this
year. Last year’s CPI was 100 and this year’s came in at 110.
1. How much inflation has occurred?
2. Are you making more money in real terms?
Inflation and Interest Rates
1. The cost of borrowing will rise as inflation rises
2. Financial institutions will charge an
inflation premium
Real & Nominal Interest Rates
Real interest rate = Nominal interest – inflation
Example:
You borrowed $1000 for one year.
Nominal interest rate - 15%
During the year inflation - 10%
How does inflation impact people ?
CONGRATULATIONS!
You have just landed a new job as an economic advisor to
the President of the United States. You are examining
current economic conditions in order to advise the
President on what policy actions would best help to
improve the economy. The question which you have been
tasked to answer is this: Would more or less inflation
best help the current economy?
What you know: Q4 rGDP growth 2.2%
Q1 rGDP growth ~2%
Inflation rate - 0.1 %
Elevated unemployment 5.5%
Wages are stagnant
Fewer homes in foreclosure
(borrowers unable to pay)