Inflation

Essential Standards The student will define the Consumer Price Index (CPI) and inflation. The student will explain how inflation is calculated. The student will give examples of who benefits and who loses from inflation.

Inflation Inflation ► Over the years, prices rise and fall… ► In the American economy, they have mostly risen. ► Inflation—a general increase in prices. ► Purchasing power—the ability to purchase goods & services… ► As prices rise, purchasing power… ► Declines.

Nominal and Real Values ► To compare the difference between prices over time, economists use two measurements. 1. Nominal value—prices NOT adjusted for inflation… 2. Real value—prices that ARE adjusted for inflation. ► For example—a movie ticket cost 35 cents in 1945… ► 35 cents is the nominal value… ► But 35 cents was WORTH $4.08 in 1945… ► So the REAL cost of a ticket in 1945 was $4.08.

"In 1980, gas was only $1.30 per gallon!" This statement is misleading because... A.) there were fewer cars on the road in B.) in 1980, the US was more economically prosperous. C.) $1.30 only reflects the nominal value of gas in D.) $1.30 was worth much less in 1980 than it is today.

Measuring Inflation Consumer Price Index—Is computed each month by the Bureau of Labor Statistics. It measures the prices of a “market basket”… A representative collection of goods and services.

Contents of the Market Basket Utility Gas—100 therms Utility Gas—100 therms Electricity—500 Kwh Electricity—500 Kwh Fuel oil—per gallon Fuel oil—per gallon Gasoline—regular unleaded Gasoline—regular unleaded Bread—white Bread—white Ground beef—all types—per pound Ground beef—all types—per pound Whole chicken—per pound Whole chicken—per pound Milk—all types—per gallon Milk—all types—per gallon Apples—red delicious Apples—red delicious Bananas Bananas Naval oranges Naval oranges Tomatoes Tomatoes Orange Juice—Frozen Orange Juice—Frozen Coffee—ground roast—all sizes Coffee—ground roast—all sizes Iceberg lettuce Iceberg lettuce Eggs—large—per dozen Eggs—large—per dozen

Average price of unleaded regular gasoline in January of 2001: $1.66 Average price of same in July of 2004: $2.13 Average price of same in July of 2008: $4.30 Average price of same in December of 2008: $1.91 Average price of same in September, 2012: $3.93 Average price of same in January, 2013: $3.35 Average price of same in January, 2014: $3.32

Degrees of Inflation ► When the inflation rate stays between 1% and 3%, it causes few problems… ► When it rises above to 5%, the economy can become unstable. ► Hyperinflation— out of control inflation…can go as high as 100% to 500% per month.

Several different theories are used in explanation. Economists are unsure of exactly what causes prices to rise at every level.

The Quantity Theory Quantity inflation occurs when governments… Quantity inflation occurs when governments… PRINT TOO MUCH MONEY. PRINT TOO MUCH MONEY. Money is the same as any product… Money is the same as any product… When there is TOO MUCH of something… When there is TOO MUCH of something… What happens to its value? What happens to its value? It drops! It drops! This is a $10 million bill from Zimbabwe… This is a $10 million bill from Zimbabwe… It is worth approximately 25 cents in US currency. It is worth approximately 25 cents in US currency.

Demand- Pull Inflation States that inflation occurs when demand for goods and services exceeds supplies. States that inflation occurs when demand for goods and services exceeds supplies. During wartime, or after a natural disaster, demand jumps… During wartime, or after a natural disaster, demand jumps… Leading to higher prices. Leading to higher prices.

Cost-Push Inflation Inflation occurs when producers raise prices to meet increased costs. Inflation occurs when producers raise prices to meet increased costs. If MINIMUM WAGE is increased… If MINIMUM WAGE is increased… Producers increase PRICES. Producers increase PRICES. Whenever the COST OF DOING BUSINESS PUSHES UP PRICES— Whenever the COST OF DOING BUSINESS PUSHES UP PRICES— The result is COST-PUSH INFLATION. The result is COST-PUSH INFLATION.

Which of the following is the BEST example of a situation that would cause "demand-pull" inflation? A.) OPEC raises oil prices. B.) an increase in corporate taxes causes overall prices to rise. C.) an earthquake wipes out supply lines west of the Rocky Mountains.

Which of the following is the BEST example of a situation that would cause "cost push" inflation? A.) the deportation of thousands of illegal immigrants forces US business to employ higher-paid American workers. B.) the end of the Afghanistan War causes a dramatic increase in tourism to that nation. C.) Kenya decides to address its debt crisis by injecting $30 billion in currency into the economy. D.) a tsunami in Japan wipes out the infrastructure for delivering essential goods and services.

The Effects of Inflation on WAGES ► Inflation negatively impacts wage raises. ► The average teacher received a 2.1% raise in 2005— ► So our paychecks grew in size by 2.1%. ► However, the rate of inflation that year was 3.1%. ► So those paychecks were WORTH 3.1% LESS than they were worth the previous year. ► So in REAL TERMS, what happened? ► Teachers received a 1% pay reduction in 2005.

Inflation is bad for SAVERS… Inflation negative impacts INTEREST. If you have savings in a bank that pays 2% interest— The AMOUNT in your account is increasing by 2%-- BUT—if the rate of inflation is 3%-- That money is actually LOSING VALUE— 1% per year.

Inflation is good for BORROWERS If I borrow $5.00— That’s what I owe— NOT $5.00 PLUS inflation—debts are repaid in NOMINAL TERMS. SO: When I repay my $5.00, I am repaying slightly LESS MONEY— IN REAL TERMS— Than I borrowed.

Deflation Deflation is the OPPOSITE of inflation… When deflation occurs, prices DROP. This is TREMENDOUSLY DANGEROUS to an economy… The expectation of future low prices causes aggregate demand to… SHIFT TO THE LEFT. And if AD shifts sharply to the left— The economy collapses. Deflation caused the Great Depression— And if deflation appears, the government will work aggressively to counteract it.

Governments tend to pursue policies that have positive effects upon the lives of a MAJORITY of the population. Knowing what you know about the habits of the average American, you might ASSUME that... A.) the government tends to promote an environment of mild inflation. B.) the government tends to promote an environment of mild deflation. C.) the government tends to promote an environment of massive inflation. D.) the government tends to promote an environment of massive deflation.