Inflation

Today’s Objective After today’s lesson, students will be able to… Explain inflation and its causes Calculate both CPI and the inflation rate Essential Skill: Gather and organize information

Do Now Answer Questions 1, 2, and 3 on the packet. Do not continue past first three questions Be prepared to share your answers.

Measuring Inflation A market basket is a bundle of goods and services that an average consumer might buy

Measuring Inflation The Consumer Price Index (CPI) is a measure of the overall price level faced by a typical consumer

Candy Auction Two rounds Highest bidder gets the good Must be able to pay for the good

Candy Auction Market Basket When economists want to see how prices have changed over time, they use a system of calculation that utilizes a hypothetical market basket. A market basket is a set of consumer goods and services that is used to compare changing price levels over time. What six items were in our classroom’s market basket? 1. 2. 3. 4. 5. 6.

Calculate the CPI Now that we know the cost of the market basket in the first round and the cost of the market basket in the second round we can calculate CPI. CPI = Cost of the market basket in round 2 Cost of the market basket in round 1 X 100 (Base year)

Calculating Inflation Rates New CPI-Old CPI Old CPI Inflation Rate = x100

Defining Inflation Inflation is a rise in the price level The inflation rate is the annual percentage increase in the price level Deflation is a decline in the price level

Costs of Inflation True Costs of High Inflation Shoe leather costs are the costs of time and effort involved in frequent trips to the bank or ATM to avoid holding much cash during periods of high inflation

Costs of Inflation True Costs of High Inflation Hyperinflation is very rapid inflation Hyperinflation usually leaves a country’s currency worthless Bread in Germany Nov 1918 = 1 mark Nov 1922 = 163 marks Sep 1923 = 1,500,000 marks Nov 1923 = 200,000,000,000 marks

Costs of Inflation True Costs of High Inflation Menu Costs are the costs of updating prices due to inflation Price changes not just in restaurants but in grocery stores and sales contracts – across the economy changes

Costs of Inflation True Cost of High Inflation Unexpected Inflation In general, people who borrow money benefit when inflation turns out to be higher than expected. But people who lend money lose from higher than expected inflation Unexpected inflation makes borrowing and lending more risky. Lenders may be hesitant to lend and borrower may not wish to borrow

Causes of Inflation It is generally considered that these four events cause inflation 1. Money Supply Increase Prices will increase if “too many dollars are chasing too few goods” 2. Money Demand Decrease This has the same effect as having more money in the economy 3. Aggregate Demand Increases When people want to buy more goods, prices will rise, which is called demand-pull inflation 4. Aggregate Supply Decreases If production costs increase in an economy, the supply decreases which is cost-push inflation

The Inflation Myth Inflation reduces the number of goods and services we can buy with each dollar that we earn Price Stability exists when inflation is low – 2 or 3 % per year (optimal rate)

Deflation and its Effects Deflation – a decrease in the price level Causes consumers to reduce spending Postpone major purchases Decrease in Aggregate Demand, contraction in economic activity Dollar incomes also fall More difficult to pay debts that do not change Banks’ losses mount as more bankruptcies occur Economic activity becomes risky and spending decreases