1. Overview of Inflation
Lesson 25
Sections 14, 15

2. Inflation and Deflation (14)
Inflation: General rise in prices over time
Disinflation: Lowering the inflation rate
Deflation: General drop in prices over time
The level of Prices doesn’t matter
Real wages, Real income
The rate of change of Prices does matter
Inflation Rate
Shoe-leather costs
Increased costs of transactions because of inflation
Menu Costs
Costs of changing prices
Unit of Account Costs
As the value of money is changing so fast, it’s value is uncertain

4. Winners and Losers of Inflation
Borrowers win in high inflation
The value of money goes down over time, making the loan easier to repay
Savers Loose in High Inflation
Value of savings decline
Nominal Interest Rate
Interest Rate unadjusted for inflation
Real Interest Rate
Interest Rate adjusted for inflation
Disinflation
Lowering the rate of inflation, austerity

5. Measurement and Calculation of Inflation (15)
Prince Indexes and Aggregate Price level
Market Basket and Price Indexes
Market Basket: typical consumption of a family
Price Index: Measure of the overall price level
Price Index = [Cost of basket(year)/Cost of basket (base year)] x 100
Inflation Rate = [(Price Index in year 2 – Price Index in year 1)/Price index in year 1] x 100

6. FYI: What Is in the CPI’s Basket?
17%
Transportation
42%
Housing
15%
Food and
beverages 6%
Education and
communication
Medical care 6%
Recreation 6%
Apparel 4%
Other goods
and services 4%

7. Price Indexes CPI Consumer Price Index PPI Producer Price Index
GDP Deflator
Real GDP = Nominal GDP/GDP Deflator x 100

8. Two Measures of Inflation
Percent
per Year 15
CPI 10
GDP deflator 5
1965
1970
1975
1980
1985
1990
1995
2000
2005