Download Intro to Inflation

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Intro to inflati
AP Macroeconomics
Words of Wisdom on Inflation…
“Inflation is as violent as a mugger, as frightening
as an armed robber and as deadly as a hit man. “
Ronald Reagan
“By a continuing process of inflation, government
can confiscate, secretly and unobserved, an
important part of the wealth of their citizens.”
John Maynard Keynes
Does de(or in-)flation make us
better or worse off? Not
necessarily…
 As price$ go down, $o too
($hould) income
 That is, REAL WAGE – the wage
rate/the price level – stays the
same as prices fall.
 The rise in prices over the years
has not made us poorer because
REAL INCOME – income/the
price level – has not been
affected by the rise in overall
prices
So what?
The level of price$ is not what
matters…
What matters is the RATE (%)
OF CHANGE of price$$$$$$$!
infl
ation
Defined: The percent increase in the overall level of prices per
year (i.e. an overall increase in the price of goods)
Calculated:
Price level in year 2 – Price level in year 1 x 100 = Inflation rate
Price level in year 1
Notice…
We measure
price level along
the left vertical
axis
(dependent),
and year along
the right
horizontal axis
(independent)
“Shoe-leather” costs?
 Ever withdrawn $ from the bank
multiple times in a day, or got a
really big paycheck and went
from store to store to store to
buy certain things?
The increased costs of transactions
is aka “Shoe-leather costs” (an
allusion to the wear & tear
caused by extra trips made to
the bank to take out money for
transactions)
Infl
ation…
“Discourages people from
holding onto cash because
the purchasing power of the
cash in your wallet and
money in the bank steadily
erodes as the overall level of
prices rise” (Krugman, 136)
And the winner is…
 Inflation can produce winners & losers in an
economy
So who wins and who loses?
Usually, a lender will lose. That is, those who
lent the loans in years past now find that their
return is less. The repayment is worth less.
Then who will win?
But the consumer’s
purchasing power
is dramatically
affected, as their
money doesn’t go
nearly as far…
Nominal vs. Real…interest rates,
that is.
Just like GDP…
 Nominal Interest Rate: the interest rate that is actually
paid for a loan, unadjusted for the effects of inflation
 Real Interest Rate: the nominal interest rate adjusted
for inflation (subtract the inflation rate from the
nominal interest rate)
 Example: The loan nominal interest rate is 10%, and the
inflation rate is 6%, then 10%-6%= 4% real interest rate
A bit o’logic for ya…
If a borrower takes out a loan at a
certain nominal interest rate, and
the actual inflation rate is higher
than expected, then the borrower
will gain (winner!) because she
will ultimately be paying less
than anticipated.
So what do we do?
The only solution to inflati
on is
disinflation… which is tough.
usually requires a severe
recession…
And now…some resources…
 Inflation calculator…
http://www.econedlink.org/interactives/index.php?iid=
205&type=educator
Inflation vs. Price Index…
http://www.reffonomics.com/TRB/chapter20/inflatione
mbedded.swf
Works Cited
 Econedlink. “Inflation Calculator.”
http://www.econedlink.org/interactives/index.php?iid
=205&type=educator
 The Economics of Seinfeld.
http://yadayadayadaecon.com/clip/
 Krugman, Paul, and Robin Wells. Krugman’s
Economics for AP. New York, Worth Publishers.
 Reffonomics. www.reffonomics.com.