Fluctuations in Prices

Zimbabwean Dollars At one point, $1 = 621,984,228 Zimbabwean dollars.

The Rate of Inflation is calculated as: Inflation rate = Last year’s price index This year’s price index Last year’s price index - * 100 Inflation is an increase in the general level of prices.

Between 1956 and 1965, the general price level increased at an average annual rate of only 1.3%. In contrast, the inflation rate averaged 9.2% from 1973 to 1981, reaching double-digits during several years. Since 1982, the average rate of inflation has been lower (3.1% from ) and more stable. The Inflation Rate, average inflation rate = 3.1 % Inflation rate average inflation rate = 1.6 % average inflation rate = 9.2 %

Inflation, (a)Inflation was highest just after World Wars I and II, and during the 1970s. (b)Deflation occurred several times in the first half of the century and in 2009 as well.

International Inflation

Items Pound of ground beef$0.66$3.24 Pound of butter$0.87$2.80 Movie ticket$1.55$7.96 Sales price of existing home$23,000$185,283 New car$3,000$30,303 Gallon of gas$0.36$3.48 Average hourly wage for a manufacturing worker $3.23$19.17 Per capita GDP$5,069$43,063 Price Comparison, 1970 and 2012 In 2012, $1 had about the same purchasing power as 18 cents did in 1972

Consumer Price Index The U.S. price level rose relatively little over the first half of the twentieth century The upward slope reflects the high rate of inflation in the 1970s.

Year$ SpendingIndex Base year Year$ SpendingIndex Base year Current year spending Base year spending x 100 Creating a price index

Year$ Spending Base year Year$ Spending Base year Calculating inflation using Spending 200 – From year 1 to year 3 =.18 From year 3 to year – =.15

YearIndex YearIndex Calculating inflation using Index 100 – From year 1 to year 3 =.18 From year 3 to year 1 85 – =.15 From year 6 to year – =.12

Year$ SpendingIndex Base year Year$ SpendingIndex Base year Creating a price index

measures the impact of price changes on the cost of a typical bundle of goods and services purchased by households.

Consumer Price Index Eight categories of goods and services (Source:

2. IPI 2. IPI 1. PPI 1. PPI 3. ECI 3. ECI prices of merchandise that is exported or imported. wage inflation in the labor market designed to measure the change in the average price of the market basket of goods included in GDP (a broader price index than the CPI).

Even though the CPI and the GDP deflator yield similar estimates of the rate of inflation. Year CPI ( = 100) GDP deflator (2000 = 100) Inflation rate (percent) Inflation rate (percent) Source: CPI 2005 to – = 3.2 GDP 2005 to – = 2.9

There are 2 Kinds of Inflation 1. Anticipated inflation: A widely expected change in the price level. 2. Unanticipated inflation: An increase in the price level that comes as a surprise, at least for most individuals.

1. Substitution Bias 1. Substitution Bias 2. Quality/New Goods Bias 2. Quality/New Goods Bias Does not take into account that a person can substitute away from goods whose relative prices have risen. Does not take into account how improvements in the quality of existing goods or the invention of new goods improves the standard of living.

1. Hyperinflation 1. Hyperinflation

Inflation in Controlled Economies Brazil, Argentina, and Russia experienced hyperinflation and China and Nigeria had high inflation rates in the mid- 1990s.

Inflation in Controlled Economies Brazil, Argentina, and Russia experienced hyperinflation and China and Nigeria had high inflation rates in the mid- 1990s.

2. Money loses value 2. Money loses value increases in wages may lag behind inflation for a year or two If the minimum wage is adjusted for inflation only infrequently, minimum wage workers are losing purchasing power from their nominal wages

Inflation and the Minimum Wage The federal minimum wage dropped more than 30% 1967 to 2010, The nominal figure climbed from $1.40 to $7.25 per hour. Increases in the minimum wage in between 2008 and 2010 kept the decline from being worse

1. Savings 1. Savings 2. Loans 2. Loans 3. Wealth 3. Wealth 4. Politics 4. Politics May cause changes May increase Are easier to repay Lose value

1. Demand-Pull 1. Demand-Pull 2. Cost-Push 2. Cost-Push

1. Demand-Pull 1. Demand-Pull buyers demands greater than producers supply Price Quantity P2P2 P1P1 Q1Q1 D1D1 S1S1 Q2Q2 New price and output D 2 (increase in demand) Orig. price and output

2. Cost Push 2. Cost Push sellers’ costs are passed on to buyers Price Quantity/time P2P2 P 1 Q 1 D S 1 (initial equilibrium) Q2Q2 S 2 (new equilibrium)

1. When a price, wage, or interest rate is adjusted automatically with inflation 1. When a price, wage, or interest rate is adjusted automatically with inflation

2. Private Examples 2. Private Examples a. COLA - When a price, wage, or interest rate is adjusted automatically with inflation a. COLA - When a price, wage, or interest rate is adjusted automatically with inflation b. ARM - When the inflation rate rises, the interest rate on a loan increases as well. b. ARM - When the inflation rate rises, the interest rate on a loan increases as well. c. Contract adjustments - sellers are not locked into a low nominal selling price if inflation turns out higher than expected; - buyers are not locked into a high buying price if inflation turns out to be lower than expected. c. Contract adjustments - sellers are not locked into a low nominal selling price if inflation turns out higher than expected; - buyers are not locked into a high buying price if inflation turns out to be lower than expected.

3. Government Examples 3. Government Examples a. Income Taxes - tax rates are now indexed to rise automatically with inflation a. Income Taxes - tax rates are now indexed to rise automatically with inflation b. Social Security – rates automatically increase with inflation. b. Social Security – rates automatically increase with inflation. c. Bonds- now interest payments are adjusted for inflation. c. Bonds- now interest payments are adjusted for inflation.

Questions for Thought: 1. Suppose that the CPI was 150 at the end of last year and at the end of this year. What was the inflation rate during the year? 2. If decision makers anticipate an inflation rate of 3% at the start of a year and prices during the year rise by 7%, this is an example of a. anticipated inflation. b. an inflation rate higher than anticipated. c. an inflation rate lower than anticipated. 3. True or false: when the inflation rate is high and variable, decision makers will generally be able to anticipate year-to-year changes in inflation quite accurately.

4. How would an unanticipated 5 percent jump in inflation impact the wealth of: a. Joe, who has a 30-year home mortgage at a fixed interest rate b. The McCoy's, who hold most of their wealth in long-term fixed yield bonds c. Hanna, a retiree drawing a pension of a fixed dollar amount d. Jose, a heavily indebted small-business owner. e. Mike, the owner of an apartment complex with substantial debt at a fixed interest rate f. Tina, a worker whose wages are determined by a 3-year union contract ratified three months ago

1.Suppose that the consumer price index at year-end 2004 was 140 and by year-end 2005 had risen to 150. What was the inflation rate during 2005? a.7.1 % b.10 % c.14.2 % d.50 % 2.Which of the following is true? a. Anticipated inflation is an increase in the price level that comes as a surprise, at least to most individuals b. Unanticipated inflation is a change in the price level that is widely expected. c. Decision makers are generally able to anticipate slow steady rates of inflation with a fairly high degree of accuracy. d. Inflation will increase the prices of goods and services that households purchase but not the wage rates of workers