Inflation By.. Brent, Bob, Vikrant & Leslie

What is Inflation? Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As Inflation rises, every dollar you own buys a smaller percentage of a good or service. The value of a dollar does not stay constant when there is inflation. The value of a dollar is observed in terms of purchasing power, which is the real, tangible goods that money can buy.

Continued.. One important fact to know about inflation is that when inflation goes up, there is a decline in the purchasing power of money. Example: For example, if the inflation rate is 2% annually, then technically a $1 pack chocolate bar will cost $1.02 in a year. After inflation, your dollar can't buy the same goods that it could buy before.

The Variations of Inflation Deflation- This is when the general level of prices is failing and this is basically just the opposite of inflation. Hyperinflation- This is usually rapid inflation, this can usually lead to the breakdown of a nations monetary system. Stagflation- This is like the combination of high employment and economics stagnation with inflation.

The Consumer Price Index (CPI) This is a measure of price changes for a typical basket of consumers. This index basically monitors price changes of consumer products and determines what typical Canadian household purchase. By looking at statistics, Canada surveys their buying habits every few years.

Product Quality The index cant have any effect in changes in the quality that are unmatched by the a change in the price. Example: Items that are in the CPI shopping basket like medicines and TV's may improve a great deal in quality yet, their prices may actually not even rise. In fact they could even decrease so even while the standard of living may grow because of the increased quality, this might not be reflected in the CPI.

A Change in Spending Patterns Changes in consumption patterns are still going on and quite gradual even while Statistics Canada surveys households on a regular basis to update the contents and item weights of the “shopping basket”. As well the consumers tend to buy less of the products whose prices seem to rise most.

Nominal Versus Real Income The CPI is useful for helping the consumers determine the cost of living( the amount consumers must spend on the entire range of goods and services they purchase). To see how the consumers purchasing power is affected by inflation, we can express their nominal income( the income expressed in current dollars) or income valued in current dollars as a real income( income expressed in constant base-year dollars).

The GDP Deflator The GDP Deflator is an indicator of price changes for all goods and services produced in the economy which is what separates it form the CPI.

Nominal Versus Real GDP Gross Domestic Product or (GDP) is expressed in current dollars. The Real GDP gives an indication of the purchasing power of an entire economy and to find the real GDP, economists and statisticians divide nominal GDP by the GDP deflator.

Incomes Many Labor Unions negotiate income adjustments for their members and as a result the workers wages are adjusted using the CPI or costs of living. Costs-of-living- adjustment clauses are provisions for income adjustments to accommodate changes in price levels, which are included in wage contracts. Fully indexed incomes are nominal incomes that automatically increase the rate of inflation so in this case the nominal income rises at the same rate as the prices.

Continued.. Partially indexed incomes are nominal incomes as well that increase by less than the rate of inflation. This causes real incomes to fall In contrast with indexed and partially indexed incomes, fixed incomes are nominal incomes that remain fixed at some dollar amount regardless of the rate of inflation. Basically these incomes do not change at all in response to inflation.

Borrowing and Lending In this case there are two interests rates: Nominal interest rate- which is the interest rate expressed in money terms. The nominal interest rate is basically the growth rate of your money Real interest rate- which is the nominal interest rate minus the rate of inflation, so: Once Nominal interest rate is agreed on, it is then fixed and so the lenders try to anticipate the rate of inflation for the loan period and make it into the nominal interest rate. And this rate that is built into the nominal interest rate is called the inflation premium. The proper definition for inflation premium is- a percentage built into a nominal interest rate to anticipate the of inflation for the loan period.

Costs of Inflation Inflation can be anticipated or unanticipated. If the inflation rate corresponds to what the majority of people are expecting (anticipated inflation), then we can compensate and the cost isn't high. Conflict can arise when there is unanticipated inflation, like: (1) Creditors lose and debtors gain if the lender does not anticipate inflation correctly. For those who borrow, this is similar to getting an interest-free loan. (2) Uncertainty about what will happen next makes corporations and consumers less likely to spend. This will hurt the economic output in the long run. (3) If the inflation rate is greater than that of other countries, domestic products become less competitive.

Continued.. People like to complain about prices getting higher, but they often ignore the fact that wages should be rising as well. The question shouldn't be whether inflation is rising, but whether it's rising at a quicker pace than your wages.

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