CHAPTER 11: ECONOMIC CHALLENGES SECTION 2: INFLATION PAGES: 257-263

EXAMINING PRICE FLUCTUATIONS Pages: 257-258

PRICE LEVEL Aggregate Supply: total amount of goods and services produced throughout the entire economy Supply increases as price increases The aggregate quantity of goods supplied is likely to be higher when the price level is higher

AGGREGATE DEMAND Aggregate Demand: is the total amount of spending by individuals and businesses throughout the economy Greater aggregate demand when price is low

INFLATION Increase in the average price level of all products in the economy Occurs when aggregate demand increases faster than aggregate supply When quantity demanded exceeds quantity supplied, consumers must compete for limited products, and prices go up As prices increase, value of dollar goes down

DEFLATION Decrease in price level of goods and services Aggregate demand decreases more rapidly than aggregate supply Can now buy more with your dollar because price goes down Greatest period of deflation was the Great Depression

CAUSES OF INFLATION

CAUSES OF INFLATION DEMAND-PULL INFATION Demand is faster than what economy can produce Can happen from increase in money supply or increase in use of credit FED controls money supply in the United States – pumps money into the economy or gives more credit

CAUSES OF INFLATION 2. Cost-Push Inflation Producers raise prices to cover higher resource/production costs SUPPLY SHOCKS – event that increases the cost of production for all or many firms, resulting in overall higher prices Example: (crop failure)\ OPEC – OIL 1973-1974

CAUSES OF INFLATION Wage-Price Spiral – wages go up, prices of goods go up

MEASURING INFLATION

MEASURING INFLATION LOOK AT AVERAGE PRICE LEVEL AS OPPOSED TO SPECIFIC PRICES

TWO MOST COMMON PRICE INDEXES

TWO MOST COMMON PRICE INDEXES Consumer price index (CPI)– a measure over time in the price of a fixed group of products purchased by consumers Producer Price Index (PPI) – measures average change over time in the prices of goods and services bought by producers

INFLATION RATE THE MONTHLY OR ANNUAL PERCENTAGE CHANGE IN PRICES 1 TO 3 % INFLATION RATE IS LOW HYPERINFLATION – WORST DEGREE OF INFLATION. CAN RESULT IN COMPLETE ECONOMIC COLLAPSE

EFFECTS OF INFLATION The purchasing power of the dollar The value of real wages Interest rates Saving and investing Production costs

EFFECTS OF INFLATION DECREASED PURCHASING POWER If on a fixed income the loss of the value of dollar can really hurt Give you cost of living adjustments (COLAs)

EFFECTS OF INFLATION INCREASED INTEREST RATES: Prices increased so does the interest on the money you borrow

EFFECTS OF INFLATION DECREASED SAVING AND INVESTING The higher the inflation rate the less money you get when you save – so why invest or save?

INCREASED PRODUCTION COSTS