Download Inflation 11.2

Inflation

Inflation—An increase in the average
price level of all products in an
economy.
– Ex. 2014
 Bread
= $3.00
 Automobiles= $20,000
 Wages = $16.00/Hour
2015
$3.05
$21,000
$ 16.31/Hour
2%-3% is considered normal
Measuring Inflation


1)
2)
Measuring Inflation—when
economists measure the changes in
the average price level of
goods/services in nation.
The two measuring tools that
economists use are
CPI (Consumer Price Index)
PPI (Producer Price Index)
Measuring Inflation

Consumer Price Index (CPI)—is a
measure of the average change over time in
the price of a fixed group of products.
– Reported monthly
– Reported against a fixed period (or base) time
period—currently 1982-1984.
– Market basket—representative sample of
consumer goods. Food, clothing, housing,
utilities, entertainment, transportation, health
care. Measured each month in $.
– How much did it change? = CPI
Measuring Inflation
 Calculating
CPI
CPI = weighted current price
x 100
weighted base period price
Example = $3.00 (loaf of bread in 2011) X 100
$1.32 (loaf of bread in 1983)
CPI 2011 = 227.3
Or
Access this link from the BLS (U.S. Bureau of
Labor Statistics
CPI Inflation Calculator
Inflation Rate

Inflation Rate—the monthly or yearly
% change in prices.
– The CPI is a tool that is used to calculate
Ex.Inflation rate= (CPI year A – CPI year B) x 100
CPI year B
Ex.Inflation Rate 145 – 140 x 100 = 3.57
140
Inflation Rate 3.57%
Inflation Rate
Core Inflation Rate – The inflation rate
excluding effects of food and energy prices.
Question: Why take it out?
Answer: Is a better indicator of long term
inflation because it takes out products that
frequently experience volatile price changes
due to foreign government and business
decisions as well as unexpected short term
crisises (i.e. drought, hurricane).

Measuring Inflation

Hyperinflation—is the worst kind of
inflation; it is a situation where inflation is
increasing at a rate of several hundred %
per year.
– Germany after WW 1; Germany printed more
money and by 1923, it took 4.2 trillion marks to
equal $1!!!! Check out this link for more
information on this history making event!
Hyperinflation in Germany 1923
Measuring Inflation

Producer Price Index (PPI)—is a
measure of the average change over
time in the prices of goods and
services bought by producers.
– Prices are based on some 3,200 different
products.
– The current base year is 1982.
Causes of Inflation
1. Changes in Aggregate Demand—
changes in the total amount of
spending by individuals and businesses
throughout the economy.
– Demand Pull Inflation—When aggregate
demand increases faster than the
economy can produce the goods.

The demand increases and “pulls” along
higher prices because demand is increasing
faster than supply! (More people are chasing
the same amount of goods; therefore people
can charge more for their goods).
Causes of Inflation
2. Changes in Aggregate Supply— changes
in the total amount of goods and services
produced throughout the economy.
 Cost Push Inflation—When producers
raise prices to cover higher resources costs.
– Producers must raise prices in order to cover
their higher costs.
– If they do not do this, then their profits are
reduced or even eliminated!
– Must be careful not to raise prices too high.
Causes of Inflation
Example1)If there is low unemployment (such as in expansion or
peak), companies must offer higher wages to attract
workers to their open positions and to keep their own
workers from looking elsewhere.
2)However, this increases companies’ costs. Therefore
the must raise the price of their products to keep there
profits up.
3) If prices are higher across most products (inflation),
then employers must raise wages again so that their
employees’ wages buy as much as it did the year
before.
4) But wait…the companies’ costs went up again so they
raise the price of their products again.
5) And this continues on and on in an effect known as
The Wage-Price Spiral
Causes of Inflation
3. Growth of the Money Supply
As more dollars enter the money supply
in the U.S., the value of that dollar or it’s
purchasing power (the amount it can buy)
is less. So to keep prices “stable”, the
money supply should increase at the
same rate as the economy is growing.
- Note - There are more ways to increase the
money supply than just printing new
money.
Effects of Inflation

Inflation causes changes in:
– The purchasing power of the $
– The value of real wages
– Interest rates
– Saving and investing
– Production costs
Effects on Purchasing
Power

Decreased Purchasing Power—
– The decreasing value of the dollar falls
and it buys less “stuff”.
– It hurts people on fixed incomes
(retirees).
– Many labor contracts have built in (COLA)
Effects on Income

Decreased Value of Real Wages—
when the value of workers wages fail
to keep pace with rising prices.
– $20,000 per year in 1979
– $40,000 per year today
– Adjusted for inflation = the same $ today.
Effects on Interest
Rates



Increased Interest Rates— High unexpected rates
of inflation cause banks to raise interest rates. High
interest rates can decrease consumer and business
spending. Ex. Cars, houses etc.
Decreased Saving and Investing—Ex. Bank yield
on savings 5% and inflation rate of 7%. Net loss of
2% per year! Inflation hurts savers, lenders.
(however, it helps borrowers and debtors
occassionally)
Increased Production Costs—Inflation increases
businesses costs of production.
Inflation

Deflation—A decrease in the average
price level of all goods and services in
an economy.
– Note: Aggregate demand decreases
more rapidly than aggregate supply.(Less
people are chasing the same amount of
goods and services).
 Ex.
The Great Depression