Download Inflation & Deflation

Inflation & Deflation
Aggregate=all together
• Aggregate demand and aggregate supply
considers the entire quantity of goods and
services in an economy.
• The equilibrium price in aggregate supply
and demand curves is called the price level.
S1
D1
P
Q
Inflation / Deflation
What is it?
an increase in the price level
a decrease in price level
How is it determined?
CPI= Consumer Price Index
by comparing the CPI in different years and
noting the change
CPI is higher=inflation
CPI is lower=deflation
)
• Last year’s CPI (based on 1984 prices
$216.17
• This year’s CPI
$218.70
• Inflation rate
1.17%
Present Year-Past Year
_____________________
Past Year
x
100
Can be caused by
supply-side shifts or demand-side shifts
woohoo!!
more people!!
more money!!
• Under what conditions would you expect
to see inflation (rise in price level)?
Inflation can be caused by an increase in aggregate demand
Inflation can be caused by a decrease in aggregate supply
• Under what conditions would you expect
to see deflation (fall in price level)?
Deflation can be caused by a decrease in aggregate demand
Deflation can be caused by an increase in aggregate supply
Simple Quantity Theory of Money
• If velocity and quantity of output (supply)
are constant, more money in circulation
leads to higher prices.
What does velocity mean?
velocity=the average number of times per year
a dollar is spent to buy final goods
Simple Quantity Theory of Money
• If velocity and quantity of output (supply)
are constant, more money in circulation
leads to higher prices.
MxV=PxQ
M = money supply
V = velocity
P = price level
Q = quantity of output
% change M = % change P
• Low levels of unemployment are
frequently periods of higher inflation
More working people
with
more money
(increase in aggregate demand)
remember
Monetary Policy?
• The goal is to maintain price stability and
low unemployment.
Monetary Policy
• Fed is responsible for maintaining price
stability and employment
• “Expansionary Monetary Policy”
– goal is to increase money supply
• to reduce unemployment
• to avoid deflation
• “Contractionary Monetary Policy”
– goal is to decrease the money supply
• to reduce inflation
So What?
• Negative Effects of Inflation
– hurts people on fixed incomes (the retired)
– hurts savers
– hurts lenders (helps debtors)
– hurts people who contract to be paid in the future
– makes financial decision making more difficult
• hedging = avoiding or lessening a loss by taking a
counterbalancing action.
– buy gold or some other store of value besides money
So What?
• Negative Effects of Deflation
– Great Depression!
– uneven fall in prices
• business failures
• job loss
– hurts debtors
– hurts property-owners
Stagflation
What’s up with that?
• stagnant (persistently high) unemployment
and
• inflation