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Inflation ch 13.2 What goes up must come down, unless it’s prices. What is inflation? Inflation is a general increase in prices. It’s when aggregate demand increases more than aggregate supply. Deflation: During prices go down a time of inflation purchasing power goes down. How is inflation calculated? The way to measure inflation is to use a price index which is a measurement of the average price of a group of items. Consumer Price Index (CPI) is THE price index created and used by the Bureau of Labor Statistics (BLS) it measures the “market basket” which is a collection of goods and services the average urban consumer buys. Market basket – cereal, mik, rent, clothing, airfare, gas, prescriptions, newspapers, tution, etc. Inflation rates Inflation rate is the percentage of change from one year to the next Core inflation rate: inflation of all things except the effects of food and energy prices Hyperinflation: excessive inflation that is out of control. Causes of Inflation Quantity theory: an increase in the money supply can cause inflation. Demand Pull: demand for goods rises faster than the amount of supply Cost Push inflation: Production cost up, prices up. Increase in price in natural resources or wages can cause this type of inflation. So producers raise prices to meet increased costs. Wage Price Spiral Cost push inflation can cause a wage price spiral, which is when wages go up causing prices to go up, which causes workers to ask for higher wages. Also, when unemployment falls to very low levels, we get an increase in prices. Inflation is natural A healthy economy expects to have inflation rates from 3 to 5%. It signals growth BUT… There are negative aspects of inflation 1. Purchasing power of the dollar goes down 2. Real value of wages goes down even though nominal goes up 3. Interest Rates go up to try and slow down spending 4. Savings worth less 5. Production costs go up You make $10 per hour and get a 3% raise ($.30). Inflation is 5%. Are you making more money?