Chapter Seven Inflation

The Big Ideas… The definition and causes of economic growth. The nature and cause of the business cycle. The nature of unemployment and its measurement. The definition of inflation and how it is measured. The overall effects of inflation on wealth and output.

Defining Inflation Inflation is when value of money decreases so prices increases. Inverse relationship between the value of money and prices. Each dollar of income buys fewer goods and services compared to before. Inflation reduces our "purchasing power.“ Inflation Video

Measuring Inflation The main measure of inflation in Canada and the U.S. is the Consumer Price Index (CPI). The government reports inflation rates each month and each year. Governments also uses the CPI to adjust pension benefits and income tax brackets. Rate of Inflation is found by comparing the year's CPI the CPI in the previous year. (year's index - previous year's index) / (previous year's index) x 100 = Rate of Inflation

Canada`s Historical Inflation Rate

Two Types of Inflation Demand-Pull Inflation Cost-Push Inflation “Too much spending chasing too few goods." Usually, the price level increases due to too much spending, the economy cannot produce fast enough. Cost-Push Inflation Inflation that arises on the supply, or cost, side of the economy. This type of inflation explains rising prices in terms of factors that raise per-unit production costs.

Nominal versus Real Income Nominal Income: The number of dollars you receive. Real Income: The amount of goods and services nominal income can buy, or its purchasing power. It is the nominal income adjusted for inflation. Real Income = (nominal income)/(price index, in hundredths)

Did you Actually get a Raise? If nominal income rises at the same rate as the price index, purchasing power stays the same. However, in most cases, not everybody's nominal income rises at the same rate. Your Percentage Change in Real Income = (Percentage change in Nominal Income – Inflation).

Who Does Inflation Hurt Most? Fixed Income Earners Savers Creditors (Loan Money)

Who is Unaffected or Helped by Inflation? Flexible Income Earners Debtors (Borrow Money)

Anticipated Inflation Inflation that is fully expected. This is less harmful because income receivers may be able to avoid or lessen its effects. Unanticipated or surprise inflation is more harmful. If you were a creditor, and you knew there would be inflation, how would you adjust your interest rates?

Nominal and Real Interest Rates Nominal Interest Rate = (Real Interest Rate + Inflation Premium) Real Interest Rate = (Nominal Interest Rate – Inflation) Inflation is good for borrowers, bad for creditors.

Test Preparation Questions 9, 10, and 11 on Page 178.