Inflation

Videos! Mr. Clifford!

Inflation Inflation – a rise in the level of prices Measured by CPI comparisons (year to year; month to month) Normal economic growth = 2-3% change Annual inflation Rate is 1.5% – “double digit” is very serious for U.S. Hyperinflation can be devastating to output and employment

Negative Effects Fixed income receivers (elderly retirees, government workers, minimum wage earners, landlords, etc.) Savers (paper assets lose value over time when interest rate is lower than inflation rate) Creditors (lenders are paid back in “cheaper” dollars & have a loss of “real” income)

Positive Effects Flexible-Income receivers are unaffected (COLA like SS, businesses with prices rising faster than costs, commission sales positions, any business that anticipates inflation, etc.) Debtors (borrowers pay back loans with “cheap” dollars – lower interest than inflation %)

Pull Inflation Demand – Pull Inflation Caused by changes in spending beyond the production capacity i.e. failure to produce more drives up price “too much money chasing too few goods” In long run, wages will go up as workers are in demand & cost of living increases

Push Inflation Cost – Push Inflation Caused by increase in factors of production costs Per unit production costs rise Business must raise prices to make profits “wage price spirals” as wages are the largest single production cost Also caused by “supply shocks” (raw materials or energy costs rise abruptly)

Anticipating Inflation Inflation is not as much of a problem IF we prepare for it IF we adjust nominal incomes to expected price increases IF lenders adjust nominal interest rate by charging an “inflation premium” – the amount of expected inflation Nominal interest rate = real interest rate + inflation premium (expected rate of inflation) 11% (nominal interest rate) = 5% (real interest rates) + 6% (inflation premium)

Price Index Price Index = a measure of the price of a specified collection of goods and services (a market basket) in a given year as compared to the prices of an identical/highly similar collections of goods and services PI = price of market basket in specific year x 100 Price of market basket in base year

CPI Consumer Price Index Made by the Bureau of Labor Statistics The government uses this index to measure the rate of inflation from month to month, year to year, etc. The CPI reports the price of a “market basket” of around 300 consumer goods (eggs, soap, etc.) and services (car repairs) Example: CPI = price of 1993-1995 market basket x 100 price of same basket in 1982-1984

Nominal Vs. Real GDP Mr. Clifford (again!)

Activity Work with a partner on the “Inflation and Price Indices” worksheet. This will help you with your homework!