Alomar_111_101 Inflation Another economic instability problem

Alomar_111_102 Meaning of Inflation  Is the rise in general piece level.  Not necessary that all prices are increasing  In periods of inflation, some prices are rising while some are declining  The most important: general price level, and the increase to have an affect

Alomar_111_103 Measuring Inflation  Using CPI when price index measures the general level of prices in the economy. CPI year A =(basket year A )/(basket in base year) X100  Therefore, inflation rate 2000 =CPI CPI 1999 X100 CPI 1999

Alomar_111_104 Types of Inflation 1.Demand Pull Inflation: assume that the economy is at its full capacity of production. Assume that total spending is greater than production level… what will happen to price level?

Alomar_111_105  Since all resources are fully employed, production cannot respond to this increase in demand.  Therefore, outputs cannot be expanded to meet demand  This excess demand will bid up prices, causing “demand-pull inflation”.  “Too much spending for too few goods”

Alomar_111_ Cost-Push Inflation:  This is an increase in per-unit production costs.  Per-unit production cost = Total input cost / units of outputs  This will reduce profits and reduce outputs firms willing to produce.

Alomar_111_107  Thus, the economy’s supply of goods and services declines and the price level rises.  Costs are pushing the price level upward  Sources: supply shocks: increase in costs or raw materials, energy inputs, wages…

Alomar_111_108 Redistribution Effects of Inflation  Inflation hurts some, leaves others unaffected  That is, inflation redistributes real income from some to others  Who benefits and who gets hurt?

Alomar_111_109 terminology Nominal and real income: Real income = nominal income/price index  Real wage: purchasing power of nominal wage (number of $$ received as wages, rent, interest, or profits)  Some people will be affected more than others as inflation occurs (redistribution effect)

Alomar_111_1010  The following rule tells us approximately by how much real income will change: %ΔReal in Income = %Δ in nominal income - %Δ in price level  Anticipation and the effect of inflation?

Alomar_111_1011 Who is Affected by Inflation? Unanticipated inflation hurts: 1.Fixed income receivers 2.Savers 3.Creditors  Who is Unaffected by Inflation? 1.Flexible income receivers 2.Debtors

Alomar_111_1012 Anticipated Inflation  The redistribution effects of inflation are less sever or can be eliminated when people can expect inflation and can adjust their nominal incomes to reflect the expected price-level increases.  Save more now (consume less)

Alomar_111_1013 Hyperinflation  Is an extremely high rate of inflation.  Agents expect inflation rate to even gets higher, leading them to “spend now”.  May cause economic collapse  Uncertainty about future prices