Inflation Frederick University 2014

Definition A process of irreversible increase in the overall price level, involving a change in relative prices

Typology According to the form – open and hidden According to the rate of price growth – moderate, galloping, hyperinflation According to expectations anticipated and unanticipated According to source – driven by MS or MD, by AS

Demand pull inflation CPI Y AD AD’

Supply push inflation CPI Y AD AS AS’ stagflation

Measurement GDP deflator Consumer Price Index (CPI)

GDP deflator Nominal GDP – GDP at current prices Real GDP – GDP at constant prices (base year prices – chosen year) Index – the change in the value of an indicator compared to its previous level, taken as a base (= 100) GDP deflator = (Nominal GDP : Real GDP) х 100 GDP deflator is a current year weighted index

Consumer Price Index Consumer basket Relative shares of goods in the consumer basket - g CPI = [(P 1A / P 0A )x g 0A + (P 1B /P 0B )x g 0B ] x 100 Rate of inflation = [(CPI – 100)/100]x 100% CPI is a base year weighted index

CPI an example There are two goods in the economy – movies and wine Р of movies in 2010 г. = €5. Р of wine in 2010 г. = €4. Q of movies in 2010 г. = 400 Q of wine in 2010 г. = 2000 The cost of consumer basket = 400 x € x €4 = =€ € 2000 out of these €10000 were spent on movies. This makes 20% or 0.2 of all money spent on movies. Thus, the relative weight (g) of movies in 2010 = 0.20 g of wine = 0.80 Р of movies in 2011 = €8 Р of wine in 2011 = €3 CPI = [(8/5) х (3/ 4) x 0.80) x 100 = 93 Rate of inflation = = ( )/100 x 100% = = -7% If the CPI were above 100, the rate of inflation would have been positive.

The Phillips curve Rate of inflation U’ SRPC 1 SRPC’ U V W Z LRPC U* Z’ W’