INFLATION SSEMA1-You will illustrate the means by INFLATION SSEMA1-You will illustrate the means by which economic activity is measured

What is Inflation? Inflation is a rising in the general level of prices. Inflation reduces the “purchasing power” of money. Examples: It takes $2.50 to buy what $1 bought in 1982 It takes $8.12 to buy what $1 bought in 1961 When inflation occurs, each dollar of income will buy fewer goods than before.

Measuring Inflation Economist measure inflation using the: Consumer Price Index (measure of the average change over time in the price of a fixed group of products) Market Basket- Sample of 300 commonly purchased goods.

= CPI Consumer Price Index (CPI) x 100 Here is how it works: The base year is given an index of 100 To compare, each year is given an index # as well = Price of market basket in base year x 100 CPI Price of market basket 1997 Market Basket: Movie is $6 & Pizza is $14 Total = $20 (Index of Base Year = 100) 2018 Market Basket: Movie is $10 & Pizza is $15 Total = $25 (Index of ) This means inflation increased 25% b/w ’97 & ‘18 Items that cost $100 in ’97 cost $125 in ‘18

Inflation Rate The inflation rate is the % change of prices from month to month or year to year. Examples: Over the last 12 months inflation rate was 2.07% U.S. prices have increased 151% since 1982 (base year). The inflation rate in Bolivia in 1985 was 50,000% This is called Hyperinflation A $25 meal today would cost $12,525 a year later = CPI in year 1 x 100 Inflation Rate CPI in year 2 – CPI in year 1

July 2008, the nation of Zimbabwe experienced 2,600% inflation.

World Inflation Rates

Three Causes of Inflation If everyone suddenly had a million dollars, what would happen? What two things cause prices to increase? Use Supply and Demand

3 Causes of Inflation 1. The Government Prints TOO MUCH Money (The Quantity Theory) Governments that keep printing money to pay debts end up with hyperinflation. There are more “rich” people but the same amount of products. Result: Banks refuse to lend and GDP falls Examples: Bolivia, Peru, Brazil Germany after WWI

What would happen if the government printed money to pay off the national debt all at once?

3 Causes of Inflation 2. Demand Pull- Aggregate Demand increases faster than the economy’s productive capacity. Quantity demanded exceeds quantity supplied Demand pulls the price up Increase money supply or increase use of credit “Too much money chasing too few goods.”

3 Causes of Inflation 3. Cost Push- producers raise the price to cover resources Set prices high enough to cover their cost and make a profit Decrease production pulls prices higher Supply Shock- economic disturbance that forces a decrease in production for all or most companies Wage-price spiral- asking for a raise and receiving one results in companies raising prices

The Wage-Price Spiral A Perpetual Process: 1.Workers demand raises 2.Owners increase prices to pay for raises 3. High prices cause workers to demand higher raises 4. Owners increase prices to pay for higher raises 5. High prices cause workers to demand higher raises 6. Owners increase prices to pay for higher raises

Negative effects of Inflation Decreased Purchasing Power- Hurts people living on a fixed income. To help with this, a cost of living adjustment may be included in contracts. 2. Decreased Value of Wages- Salary increases just allow you to keep pace with the cost of living

Negative effects of Inflation cont. 3. Increased Interest Rates Can greatly increase the cost of borrowing money. Often decreases consumer spending. 4. Decreased Savings and Investing When inflation grows faster than your interest rate, you actually lose purch. power. 5. Increased Production Cost Inflation makes production costs rise.