Download Inflation

Inflation
Is a dollar today worth more or
less than a dollar tomorrow?
Example – Movie Box Office
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Top 5 grossing films of all-time
Actual receipts
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1.
2.
3.
4.
5.
6.
Avatar (09)
Titanic (97)
Dark Knight (08)
Star Wars (77)
Shrek 2 (04)
ET (82)
Others include Pirates, recent
Star Wars, Spider Man &
Transformers vs Titanic, Jaws,
Dr. Zhivago, Jungle Book &
Snow White.
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Top 5 Grossing Films of all-time
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Adjusted Receipts
Gone With The Wind (39)
Star Wars (77)
Sound of Music (65)
ET (82)
10 Commandments (56)
Aggregates
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Aggregate = The total market
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Aggregate Demand
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Total amount of goods & services
demanded.
Aggregate Supply
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Total amount of goods & services supplied.
Price levels
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Given aggregate supply & demand,
there is a price level for an economy.
Inflation
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price levels increase
Aggregate demand > aggregate supply
Deflation
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Price levels decrease
Aggregate demand < aggregate supply
Causes of Inflation
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2 types
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Demand-pull inflation
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Aggregate demand > productive capacity
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Causes include increases in money supply or credit.
Cost-push
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Prices increased by producers to cover higher
costs of production.
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Supply shocks such as changes in oil prices, crop
failures & natural disasters.
Inflation & Expectations
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Consumers
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Expect future inflation
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Expect low inflation
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Buy now.
Delay purchases.
Producers
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Expect inflation
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Raise prices.
Measuring Inflation
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CPI – Consumer Price Index
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Market basket of goods
CPI’s basket represents the entire
economy.
Measures same goods every year.
Tracks changes from year to year.
PPI – Producer Price Index
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Measures goods & services bought.
The Market basket
The Market Basket
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What goes into the CPI?
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Housing
Transportation
Food
Entertainment
Medical Care
Education and Communication
Apparel and Upkeep
Other
39.6%
17.6%
16.3%
6.1%
5.6%
5.5%
4.9%
4.3%
Calculating CPI
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Step One: Set Market Basket
Step Two: Calculate CPI
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P1*Q1+P2*Q2+…+PN*QN=CPI
Step Three: Convert to base year
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CPICY/CPIBY*100
Calculating Inflation Rate
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Equals rate of change of CPI’s
I = (CPIY2 – CPIY1)/CPIY1*100
Example:
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Year A CPI = 140
Year B CPI = 145
I = (145-140)/140*100 = 3.57%
Yearly CPI numbers
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2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
211.14
211.08
202.42
198.30
190.70
185.20
181.70
177.10
175.10
168.80
1999
1998
1997
1996
1995
1994
1993
164.30
161.60
159.10
154.40
150.30
146.20
142.60
1992
138.10
1991
134.60
1990
127.40
Inflation & the dollar
Interpreting Inflation rates
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Moderate
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Historically
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3.41 % (since 1913)
Double digit inflation
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1 to 3 percent.
Considered high in developed countries
Hyper inflation
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Runaway inflation, can reach rates in excess of
100%.
5 Major Effects of Inflation
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Decreased purchasing power
Decreased value of real wages
Increased interest rates
Decreased savings & investing
Increased production costs
Decreased Purchasing Power
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Purchase less for same amount.
Affects People on Fixed-Incomes.
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Pensions, disabilities.
COLA’s
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Cost of living adjustments.
Decreased Value of Real
Wages
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Nominal vs. Real wages
Typically, wages increase more than
inflation
Huge issue if real wages decrease
Increased Interest Rates
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Interest rates reflect
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Expectations on future value of the dollar
Demand for money
Profits
Effects of high interest rates
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Decrease in consumer spending
Credit card costs increase
Decreased Savings &
Investments
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Savings
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Real value of money less
Value of savings therefore less
Investing
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Need for higher returns to compensate for
inflation.
Cheaper to purchase now b/c of stronger
dollar – decreases amount for investing.
Increased Production Costs
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Most businesses operate with shortterm or market pricing on costs.
Inflation hits production costs quickly.
Long-term debt at lower rates one as
benefit of inflation for companies.