Inflation *

INFLATION: An increase in the average price level of goods and services produced in an economy. (study guide definition) *

How is inflation measured? By using the Consumer Price Index (CPI)! 400 goods and services are calculated in the “Market Basket” Each group of items is weighted to reflect how much consumers spend on it Re-calculated yearly to find the difference Growth of the price index = inflation! *

Normal: A certain amount of inflation is normal and expected. The normal (“creeping”) rate of inflation is 3.4% per year. Abnormal: HYPERINFLATION: Inflation goes into overdrive! Germany in the 1920’s (Loaf of bread: 1 mark in 1920, 2 billion marks in 1923) Zimbabwe, 2008 (1000%) (Study Guide) DEFLATION: Prices go down over time Good for consumers, savers, & lenders Bad for borrowers & businesses *

What causes inflation? Quantity Theory: ; Quantity Theory: Too much money circulating!!! Rapid wage increases? Demand-Pull Theory: Demand for goods exceeds supply & causes a shortage…“Pulls” prices upwards Cost-Push Theory: Costs of production increase, so prices are “pushed” upwards Result of the Wage-Price Spiral *

Wage-Price Spiral: A vicious cycle in which rising prices drive up wages and then rising wages drive up prices. The result is an inflationary spiral that can be hard to break. *

What causes inflation: Theory of money – see velocity Production increases Rapid wage increases Market power Velocity of Money: the average number of times a year a dollar is spent on final goods or services. *

Inflation Calculation Assignment Complete inflation calculation assignment Bureau of labor statistics Class discussion - What observations do you have about the inflation rates for your market basket (6 goods)? *

Sources of Inflation Inflation can originate on either the demand side of the economy or the supply side of the economy. If aggregate demand increases and aggregate supply stays the same, inflation will occur. *

Demand Side Inflation Possible cause Increase in the money supply As a result of people having more money to spend, the price level increases Draw a graph on study guide showing increase in demand. *

Supply Side Inflation Possible cause event that lowers the output of goods (ex. Drought) As a result, the supply of goods in the economy is smaller, and price level increases Draw a graph on study guide showing increase in supply. *

Effects of Inflation Biggest losers!!! (People most hurt by inflation) People on a fixed income Retired As Inflation ↑, Purchasing Power ↓ *

Effects of Inflation Biggest WINNERs Effects of Inflation Biggest WINNERs!!! (People least affected by inflation) Borrowers (paying back loans with devalued money) Homeowners As inflation ↑, these people see their “wealth” increase! *

Wages and Inflation What happens when wage increases are more than the inflation rate More money to spend, likely rise in inflation What happens when wage increases are less than the inflation rate Less money to spend, likely deflation *

Let’s practice looking at some data… What might explain the fluctuations between 1933 and 1940? Based on what you know about the inflation rate and how it’s determined, what might explain the deflation before 1933? During which of these years was the inflation rate the lowest? The highest? What might explain the increase in inflation after 1940? *