Download Ch. 14 Inflation Ppt.

Ch. 14: Inflation
CIE3M1-01
M. Nicholson
What Is Inflation?
Inflation is the increase in the prices of
goods & services over a period of time
 Figure 14.1 pg. 290  comments?

How To Increase Your Income Without
Doing More Work
Cost of living allowances can be
calculated in the following manner:
(Costs Today / Past Costs) x 100%
 Gas = $1.25 / $0.50 x 100% = 250%

The Consumer Price Index
CPI is a measure of the general changes in
market prices of a selected group of
goods & services (< 400) purchased by
the typical urban (> 30,000) family
 Products are weighted according their
proportion of total household
expenditures with seven components
(food 18.1, housing 36.3, clothing 8.7,
transportation 18.3, health 4.2, recreation
and education 8.8, tobacco / alcohol 5.6)

The Consumer Price Index
Current base year 1986 given the number
100 whereas 1990 is 117, which means
there was 17 % inflation (Current Year
CPI / Base Year CPI x 100%)
 CPI, GDP and unemployment rate are the
three most commonly used indicators of
how the Canadian economy is doing

Inflation Since 1940
1940 – 42 prices rose rapidly because of
WW 2
 1943 – 45 government controlled prices
 1946 – 49 rapid price increase with end
of war
 1951 Korean War drove up prices

Inflation Since 1940
1.
2.
3.
4.
5.
6.
1953 – 65 (low inflation of 1.5%)
1966 – 72 (higher inflation of 4.8%)
1973 – 82 (9% inflation)
1983 – 91 (< 5% inflation)
1991 (low inflation of < 2%)
Figure 14.5 pg. 293 #1 - 3
Inflation: The Winner & Losers
Those who owe money (borrowers) win
and those who are owed money (lenders)
lose
 Inflation Race – expanding businesses,
workers in powerful bargaining positions,
and those who borrowed money are the
winners
 Declining industries, workers in weak
bargaining positions, and those on fixed
incomes lose

Inflation: The Winner & Losers
Inflation shifts benefits from creditors to
debtors
 Hyperinflation or extremely high rates of
inflation devastates an economy causing
money to become worthless
 people turn to barter destroying benefits
of specialization (higher quality, cheaper
products and more leisure time)

Inflation: The Winner & Losers
Deflation – decrease in the general level
of prices over time (Depression 1930s)
 Pgs. 301 – 302 #1 - 2

What Causes Inflation?
Full employment and no inflation is the
ideal situation (i.e. full bucket)
 Bucket shows real output which is
adjusted for inflation so that different
year’s outputs can be compared

What Causes Inflation?
Demand-Pull Inflation
If full employment exists (full bucket) and
injections (X + I + G) > leakages M + S +
T) then no more goods & services can be
produced, only prices will rise (inflation,
water spilling out of the bucket)
 Demand for goods & services > quantity
of goods & services pulls up prices

Demand-Pull Inflation
Government Policies to Control
Demand-Pull Inflation
1.
2.
3.
Contractionary Fiscal Policy – G ↓ and T
↑  ↑ gov’t revenue for use during a
recession
Contractionary / Tight Money Policy –
Sell bonds, ↑ the bank rate and use moral
suasion to discourage bank loans
Pg. 303 #3 - 5
Applying Fiscal & Monetary Policy To
Demand-Pull Inflation
1.
2.
Unemployment – the biggest negative
consequence of controlling inflation with
contractionary policies
Delays in applying the policy –
recognition lag; decision lag;
implementation lag
Cost-Push / Sellers’ Inflation
resource costs (e.g. ,wages) increase 
producers pass on the increased costs to
consumers in the form of higher priced
products
 The worst situation is the twin evils of
inflation & unemployment existing at the
same time  stagflation

Cost-Push / Sellers’ Inflation
Stagflation - occurred in the 1970s when
OPEC raised the price of oil which was
an essential source of energy for the
Canadian economy (e.g. bucket has holes
on the side that leak)
 Oil Crisis Video
 Oil Crisis Video

Cost-Push / Sellers’ Inflation
Income vs. Expenditure Method Of
Measuring The Economy
C + I + G + (X – M) = GDP 
Expenditure Method
 M (supply of money) x V (velocity of
circulation of money) = GDP
 GDP = P x Q  MV = PQ
 Recession – M ↑ x V = P x Q↑
 Full Employment – M ↑ x V = P ↑ x Q

Income vs. Expenditure Method Of
Measuring The Economy
Monetary Rule – economist Milton
Friedman believed that the money supply
(M) should only be increased by the same
amount as the increase in the amount of
GDP which would solve the problem of
inflation
 ∆% GDP ↑ = ∆% M ↑

Income vs. Expenditure Method Of
Measuring The Economy
Keynesians believe in using G and T to
solve the problems of the economy
 Monetarists believe G and T cause more
problems than they solve and the
economy would be healthiest if money
supply grows proportionally with GDP

Wage & Price Controls
Policies aimed at restraining inflation by
holding wages and prices below a specific
level
 Successful controls during WW 2 but
unsuccessful controls in the 1960s and
70s. Video

Wage & Price Controls
1.
2.
3.
4.

lack of united support
large bureaucracy needed
interference with the operation of the
market
import prices
all contributed to the lack of success