I.) Inflation: a.The value of the dollar decreases b.Takes more dollars to purchase the same amount of goods II.) Winners and Losers of Inflation !!!! As a general rule, borrowers benefit from inflation!!!

II.) Winners and Losers of inflation (cont.) a. Anticipated inflation: i.Consumers, banks, and commercial firms expect prices to increase; therefore, they build that expectation into their decisions.  Examples: 1.Workers expect prices to increase, therefore, they demand higher wages 2.Banks expect price increases, so they increase the interest rates. b. Unanticipated inflation: i.Consumers, banks, and commercial firms do not expect the level of inflation, therefore, they do not build the price increases into their decisions and behaviors.

c. Why do borrowers benefit from Unanticipated Inflation?  Individuals who borrow money, receive the loan before the price of goods increase. However, they pay the money back later, after prices increase, with money that is worth as much. The chart below demonstrates the effect of unanticipated inflation:

2015 Price of a basket of goods: $1000 Amount borrowed: $10,000 Number of baskets able to purchase w/ loan: 10 Expected inflation: 3% Interest rate: 5% Actual inflation: 8% 2020 Price of a basket of goods after inflation: $ Amount paid back: $ Number of baskets able to purchase w/ money repaid: 8.69 Expected inflation: 3% Interest rate: 5% Actual inflation: 8% Equation to calculate amount owed with interest: A(t)=P(1+r) t If we calculate the loan in terms of the number of baskets the money is able to purchase— The borrower borrowed 10 baskets in 2015 and only had to pay back 8.69 baskets five years later. Therefore, the borrower essentially enjoyed a net gain of 1.31 baskets of goods!

 Government policies that lead to inflation— › ie. Raising the minimum wage, increased government spending, increased taxes on domestic goods and services:  Encourage irresponsible borrowing habits;  Weakens financial institutions; and  Reduces the amount of money households are willing to place in savings, which in turn, reduces the amount of money that banks have to lend, which causes the supply of loanable funds to decrease, which causes the price of money (interest rates) to increase.

(Price of Money)

 Identify whether each of the following examples leads to a person or group being hurt or helped by unanticipated inflation. Explain your answer. 1. Banks extend many fixed-rate loans. 2. A Farmer buys machinery with a fixed rate loan to be repaid over a ten-year period.

3. Your family buys a new home with an adjustable-rate mortgage. 4. Your savings from your summer job are in a savings account paying a fixed rate of interest. 5. A widow lives entirely on income from a fixed-rate corporate bond.

6. A retired couple lives entirely on income from a fixed-rate pension the woman receives from her former employer. 7. The federal government has a $14 trillion debt. 8. A firm signs a contract to provide maintenance services at a fixed rate for the next five years.

9. You rent an apartment with a fixed three- year lease. 10. Parents are putting savings for their child’s college education in a bank savings account.