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Inflation: General increase in the general price level throughout an economy Doesn’t mean the price of every product is increasing Nor does a price increase in one or a few products mean that there is inflation
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Measurement of Inflation Consumer Price Index- A measure of the average change over time in the relative prices paid by urban consumers for a market basket of goods and services. CPI Price of the Most Recent Market Basket in the Particular Year Price of the Same Market Basket in 1982-1984 = x 100 Rate of Inflation = Current CPI –Past CPI Past CPI X100
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YearMarJunSepDecAnnualIR 2003184.20183.70185.20184.30184.002.2% 2004187.40189.70189.90190.30188.902.7% 2005193.30194.50198.80196.80195.303.3% 2006199.80202.90 201.80201.603.2% 2007205.35208.35208.49210.04207.342.8% 2008213.53218.82218.78210.23215.304% 2009212.71215.69215.97215.95214.54-.04% 2010217.63217.97219.63222.08218.061.6% 2011224.5226.22226.95228.35224.943.2% 2012228.77230.08231.25229.62.07% The New Millennium
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Inflation Annual Inflation Rates in the United States, 1960-2005 Inflation Rate (percent) Source: Bureau of Labor Statistics
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Inflation Source: Bureau of Labor Statistics U.S. Germany Italy Japan France 199520002005 Inflation Rate (percent) Inflation Rates in Five Industrial Nations, 1995-2005 GLOBAL PERSPECTIVE
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Demand-Pull Inflation Demand-Pull Inflation: Inflation caused by consumer demand for goods and services increasing faster than the ability of the economy to produce more goods and services. Think about an auction…
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Cost-Push Inflation Cost-Push Inflation: Occurs if business supplies less of the goods and services because of increasing costs…causing the price level to rise The increasing costs could result from higher costs of inputs or because businesses expect prices to go up and so produce less currently Soaring Food Prices and Global Warming - NYTimes.com Soaring Food Prices and Global Warming - NYTimes.com
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The Value of the Dollar Inflation reduces the purchasing power of the dollar…as price level rises each dollar can buy less Lenders (Banks) Money loaned out will have less real value than the money that was originally provided Most banks compensate for inflation with a higher interest rate
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Savers Households that have been saving money will see the real value of their savings decrease People on Fixed Incomes Cost of living will increase, however, their income level will not…Causes a decrease in their STANDARD OF LIVING Some people on fixed incomes have a COLA Cost of Living Adjustment (Social Security)
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Flexible Income Receivers COLA flexes income automatically to adjust for inflation Unanticipated inflation may cause an increase in income even when prices may fall/adjust Debtors Principal and Interest are paid back with eroded dollar value thus Banks see decrease in their purchasing power Federal Government pays back debt with dollars that have less purchasing power with inflated tax revenue
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Which is going to be worse? UNANTICIPATED UNANTICIPATED Inflation creates problems for the economy because… The economy is dependent on prices to coordinate resources efficiently When there is uncertainty about inflation, it becomes more difficult and costly to plan This creates a less efficient economy
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Expecting inflation is a self-fulfilling prophesy…WHY? When consumers expect prices to go up, they buy more goods (Demand Shifts Right)…thus creating Demand Pull Inflation When suppliers expect prices to go up, they will decrease supply (Supply Shifts Left)… thus creating Cost-Push Inflation
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