Download Economic Fluctuations, Unemployment, and Inflation

Fluctuations in
Prices
Zimbabwean Dollars
At one point,
$1 = 621,984,228 Zimbabwean dollars.
• Inflation is an increase in the general level of prices.
• The Rate of Inflation is calculated as:
Inflation
rate =
This year’s
price index
-
Last year’s
price index
Last year’s
price index
* 100
The Inflation Rate, 1956-2006
•Inflation rate
•15
•10
•1973-1981 average
inflation rate = 9.2 %
•1956-1965 average
inflation rate = 1.6 %
•1983-2006 average
inflation rate = 3.1 %
•5
•0
•1956•1960 •1965 •1970 •1975 •1980 •1985 •1990 •1995 •2000 •2005
• Between 1956 and 1965, the general price level
increased at an average annual rate of only 1.3%.
• In contrast, the inflation rate averaged 9.2% from 1973
to 1981, reaching double-digits during several years.
• Since 1982, the average rate of inflation has been lower
(3.1% from 1983-2006) and more stable.
Inflation, 1913 - 2014
(a)Inflation was highest just after World Wars I and II, and
during the 1970s.
(b)Deflation occurred several times in the first half of the
century and in 2009 as well.
International Inflation
Price Comparison, 1970 and 2012
Items
1970
2012
Pound of ground beef
$0.66
$3.24
Pound of butter
$0.87
$2.80
Movie ticket
$1.55
$7.96
Sales price of existing home
$23,000
$185,283
New car
$3,000
$30,303
Gallon of gas
$0.36
$3.48
Average hourly wage for a
manufacturing worker
$3.23
$19.17
Per capita GDP
$5,069
$43,063
•In 2012, $1 had about the same purchasing power as
•18 cents did in 1972
Consumer Price Index
The U.S. price level rose relatively
little over the first half of the
twentieth century
The upward slope reflects the high rate of inflation in
the 1970s.
Creating a price index
Year
1
$ Spending
170
2
180
•Current
3 Base year
year spending
200
•Base year spending
4
200
Index
85
90
•x 100
100
100
5
224
112
6
250
125
7
280
140
Calculating inflation using Spending
Year
$ Spending
1
170
2
180
3
Base year
200
4
200
5
224
6
250
7
280
•From year 1 to year 3
•200 – 170
•= .18
•
170
•From year 3 to year 1
•170 – 200
•
200
•= .15
Calculating inflation using Index
Year
Index
1
85
2
90
3
100
4
100
5
112
6
125
7
140
•From year 1 to year 3
•100 – 85
•
85
•= .18
•From year 3 to year 1
•85 – 100
•
100
•= .15
•From year 6 to year 7
•140 – 125
•
125
•= .12
Creating a price index
Year
$ Spending
Index
1
170
85
2
180
90
200
100
4
200
100
5
224
112
6
250
125
7
280
140
3
Base year
measures the impact of price changes on the cost
of a typical bundle of goods and services
purchased by households.
Consumer Price Index
Eight categories of goods and services
(Source: www.bls.gov/cpi)
1.
prices paid for supplies and inputs
PPI by producers
prices of merchandise that is
2. IPI exported or imported.
3. ECI
wage inflation in the labor
market
designed to measure the change in the average
price of the market basket of goods included in
GDP (a broader price index than the CPI).
•Year
•1996
•1997
•1998
•1999
•2000
•2001
•2002
•2003
•2004
•2005
•2006
•CPI
•Inflation rate
•GDP deflator
•Inflation rate
•156.9
•160.5
•163.0
•166.6
•172.2
•177.1
•179.9
•184.0
•188.9
•195.3
•201.6
•3.0
•2.3
•1.5
•2.2
•3.4
•2.8
•1.6
•2.3
•2.7
•3.4
•3.2
•93.9
•95.4
•96.5
•97.9
•100.0
•102.4
•104.1
•106.0
•109.4
•112.7
•116.0
•1.9
•1.7
•1.1
•1.4
•2.2
•2.4
•1.7
•1.8
•2.8
•3.0
•2.9
•(1982-84 = 100)
•(percent)
•(2000 = 100)
•(percent)
•Source: http://www.economagic.com.
Even though the CPI and the GDP deflator yield
similar estimates of the rate of inflation.
•CPI 2005 to 2006
•195.3 – 201.6•= 3.2
•
195.3
•GDP 2005 to 2006
•112.7 – 116
•= 2.9
•
112.7
There are 2 Kinds of Inflation
1. Anticipated inflation:
A widely expected change in the price level.
2. Unanticipated inflation:
An increase in the price level that comes as
a surprise, at least for most individuals.
1. Substitution Bias
•Does not take into account that a person
can substitute away from goods whose
relative prices have risen.
2. Quality/New Goods Bias
•Does not take into account how
improvements in the quality of existing
•goods or the invention of new goods
improves the standard of living.
1. Hyperinflation
Inflation in Controlled Economies
Brazil, Argentina, and Russia experienced hyperinflation
and China and Nigeria had high inflation rates in the mid1990s.
Inflation in Controlled Economies
Brazil, Argentina, and Russia experienced hyperinflation
and China and Nigeria had high inflation rates in the mid1990s.
2. Money loses value
•increases in wages may lag behind
inflation for a year or two
•If the minimum wage is adjusted for
inflation only infrequently, minimum wage
workers are losing purchasing power from
their nominal wages
Inflation and the
Minimum Wage
• The federal minimum wage dropped more than 30% 1967 to 2010,
• The nominal figure climbed from $1.40 to $7.25 per hour.
• Increases in the minimum wage in between 2008 and 2010 kept the
decline from being worse
1. Savings
Lose value
2. Loans Are easier to repay
3. Wealth May increase
4. Politics May cause changes
1. Demand-Pull
2. Cost-Push
1. Demand-Pull
Price
S1
New price
and output
P2
Orig. price
and output
P1
D2(increase in demand)
D1
Q1 Q2
Quantity
buyers demands greater than
producers supply
2. Cost Push
Price
S2(new equilibrium)
S1(initial equilibrium)
P2
P1
D
Q2
Q1
Quantity/time
sellers’ costs are passed
on to buyers
1. When a price, wage, or interest rate is
adjusted automatically with inflation
2. Private Examples
a. COLA - When a price, wage, or interest rate
is adjusted automatically with inflation
b. ARM - When the inflation rate rises, the
interest rate on a loan increases as well.
c. Contract adjustments - sellers are not
locked into a low nominal selling price if inflation
turns out higher than expected;
- buyers are not locked into a high buying price
if inflation turns out to be lower than expected.
3. Government Examples
a. Income Taxes - tax rates are now indexed
to rise automatically with inflation
b. Social Security – rates automatically
increase with inflation.
c. Bonds- now interest payments are adjusted
for inflation.
Questions for Thought:
1. Suppose that the CPI was 150 at the end of
last year and 157.5 at the end of this year.
What was the inflation rate during the year?
2. If decision makers anticipate an inflation rate
of 3% at the start of a year and prices during
the year rise by 7%, this is an example of
a. anticipated inflation.
b. an inflation rate higher than anticipated.
c. an inflation rate lower than anticipated.
3. True or false: when the inflation rate is high
and variable, decision makers will generally
be able to anticipate year-to-year changes in
inflation quite accurately.
• 4. How would an unanticipated 5 percent jump in
inflation impact the wealth of:
• a. Joe, who has a 30-year home mortgage at a fixed
interest rate
• b. The McCoy's, who hold most of their wealth in
long-term fixed yield bonds
• c. Hanna, a retiree drawing a pension of a fixed
dollar amount
• d. Jose, a heavily indebted small-business owner.
• e. Mike, the owner of an apartment complex with
substantial debt at a fixed interest rate
• f. Tina, a worker whose wages are determined by a
3-year union contract ratified three months ago
•1.
Suppose that the consumer price index at year-end 2004 was
140 and by year-end 2005 had risen to 150. What was the inflation
rate during 2005?
•a.
7.1 %
•b.
10 %
•c.
14.2 % •d.
50 %
•2.
Which of the following is true?
•a. Anticipated inflation is an increase in the price level that comes
as a surprise, at least to most individuals
•b. Unanticipated inflation is a change in the price level that is
widely expected.
•c. Decision makers are generally able to anticipate slow steady
rates of inflation with a fairly high degree of accuracy.
•d. Inflation will increase the prices of goods and services that
households purchase but not the wage rates of workers