INFLATION a rise in the general level of prices. How is it measured? Start with a market basket Hundreds of items over several categories Set a base year.

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Presentation transcript:

INFLATION a rise in the general level of prices

How is it measured? Start with a market basket Hundreds of items over several categories Set a base year We use The Consumer Price Index (CPI) is constructed using this data

Use this formula Change in price level x 100 Beginning price level = inflation rate

Example In 2000, the CPI was 111. In 2001, the CPI was 115. Calculate the rate of inflation. ( )/111 x 100 4/111 x x 100 = 3.6 %

Some inflation is okay Acceptable range is 1-3% It should be low and gradual Deflation is more of a problem and is fairly rare……..post WW1 and Great Depression

Levels of inflation Creeping inflation1-4% Galloping inflationout of control, 10%+ Hyperinflation50% year or more has reached 100s, 1000s, and even more in some countries

Causes of inflation Demand – pull (blame on consumers) Cost- push (blame on producers) Wage-price spiral ( blame producers and consumers)

Consequences of Inflation Decreases your purchasing power (how much your money will buy) Changes your spending habits and encourages debt

Who it hurts People on fixed incomes (the elderly) Savers (their money is worth less in the end) Businesses (can’t plan expenses) Creditors/lenders (the money paid back to them is worth less than when it was borrowed)

Practice Calculate rate of inflation from one year to the next YearPrice indexRate of inflation

Real v. nominal numbers Real numbers have been adjusted for inflation Ex : If NOMINAL income rose by 7%, but the inflation rate was 10%, REAL income fell by 3% Ex : If NOMINAL interest rates are 5%, and the inflation rate is 2%, the REAL interest rate is 3%