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Inflation and Deflation 12 Section 1 Inflation and Deflation © EMC Publishing, LLC

What Is Inflation? Inflation is an increase in the price level, or the average level of prices. © EMC Publishing, LLC

How Do We Measure Inflation? If the price level increases from one year to the next, the economy is experiencing inflation. For example, if the CPI increases from 230 in one year to 235 in the next year, the inflation rate is 2.17 percent. © EMC Publishing, LLC

Demand-Side Versus Supply-Side 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 Demand pull inflation. Supply-side inflation Cost push inflation © EMC Publishing, LLC

The Simple Quantity Theory of Money The simple quantity theory of money presents a clear picture of what causes inflation. To understand this theory, you need to understand velocity and the exchange equation. M x V = P x Q Money x Velocity = Price x Quantity Velocity is the average number of times a dollar is spent to buy final goods and services in a year. Changes in M x V must = Changes in P x Q © EMC Publishing, LLC

Exhibit 12-5 from the Student Text M x V = P x Q M = Money supply V = Velocity P = Price level Q = Quantity of output © EMC Publishing, LLC

The Effects of Inflation Inflation reduces the buying power of people on fixed incomes savings accounts loses value. Eats up profits or retained earnings for future investments Hedge against inflation: buy gold, real estate, art, etc. © EMC Publishing, LLC

What Is Deflation? Opposite of inflation Deflation is a decrease in the price level, or the average level of prices. A downward change in the CPI indicates deflation. © EMC Publishing, LLC

Demand-Side Versus Supply-Side Deflation Like inflation, deflation can result from a change in price or a change in supply. Drop in AD Drop in SRAS Example: Housing prices in during the Great Recession © EMC Publishing, LLC

12 Section 2 Business Cycles © EMC Publishing, LLC

What Is a Business Cycle? A business cycle includes recurrent swings (up and down) in real GDP of an economy. Economists usually talk about five phases of a business cycle. Peak. Contraction. Trough Recovery Expansion © EMC Publishing, LLC

Exhibit 12-7 from the Student Text Business cycles can be caused by several types of events: Changes in money supply Changes in business investment, residential construction, and government spending Politics Innovation Dramatic changes to supply © EMC Publishing, LLC

What Causes Business Cycles? Between 1945 and 2005, the United States went through 10 business cycles. What causes a business cycle? changes in the money supply. changes in business investment, residential construction, or government spending Political decisions Drastic changes in supply Innovation © EMC Publishing, LLC

12 Section 3 Economic Growth © EMC Publishing, LLC

What Is Economic Growth? Absolute real economic growth is an increase in real GDP from one period to the next. Per capita real economic growth is an increase in per capita real GDP from one period to the next. Per capita real GDP is real GDP divided by population. © EMC Publishing, LLC

Per Capita Real GDP Growth and the Rule of 70 The Rule of 70 states that the amount of time it would take for any variable to double is equal to 70 divided by the variable’s percentage growth rate. For example, if a variable is growing at 10 percent, it will double in 7.0 years: 70 divided by 10 equals 7.0. Rate of Growth / 70 10% / 70 = 7 years © EMC Publishing, LLC

Production Possibility Curve Economic growth can occur from a position below the PPF as shown in part (a), or a position on the PPF as shown in part (b). © EMC Publishing, LLC

What Causes Economic Growth? natural resources, labor, capital, human capital, technological advances, and incentives. more labor or increased skill of labor force. Capital investment © EMC Publishing, LLC

What Causes Economic Growth? (cont.) Human capital is the knowledge and skill that people use in the production of goods and services. Human capital includes honesty, creativity, and perseverance—traits that lend themselves to finding work. Technological advances can make it possible to obtain more output from the same amount of resources. Technological advances may result from new capital goods or new ways of producing goods. . © EMC Publishing, LLC

Two Worries About Future Economic Growth COST: pollution, more factories, crowded cities, along with increased social and psychological issues. FUTURE: no clean air or water, and no land for people to live on comfortably? © EMC Publishing, LLC

Evaluating Data for Bias The speaker’s point of view frame of reference, can change how the information is presented and interpreted. Always evaluate and analyze economic information to identify any existing bias. Consider point of view and frame of reference when you look for bias in presented data. © EMC Publishing, LLC