1. Inflation
CPI

2. SSEMA1 The student will illustrate the means by which economic activity is measured.
Explain that overall levels of income, employment, and prices are determined by the spending and production decisions of households, businesses, government, and net exports.
Define Gross Domestic Product (GDP), economic growth, unemployment, Consumer Price Index (CPI), inflation, stagflation, and aggregate supply and aggregate demand.
Explain how economic growth, inflation, and unemployment are calculated.

3. Inflation Inflation = general rise of prices over time
Deflation: general decline of prices over time
Reduces purchasing power of money
Not ALL prices may be rising
Causes interest rates to rise

4. Inflation
Anticipated Inflation = inflation rate we believe will happen
Unanticipated Inflation:
SURPRISE!! inflation
Hurts money lenders
Fixed rates = paid back w/$ buys less
Interest charged = not enough

5. Interest Nominal rate = interest in todays $$$ Real Rate:
Nominal – anticipated rate of inflation
COLA =
cost of living adjustment
Automatic increase in income to cover inflation

6. Nominal/Real Nominal Value of dollar = actual value of the dollar bill
What is on the front of the bill
Real Value: what can that dollar ACTUALLY buy
$5 today will be worth less than $5 next year.

7. Nominal/Real Nominal income= Wages, interest, profit
Real income: purchasing power
Nominal income/price index (hundredths) = real income

8. Inflation CPI: Consumer price index Used to measure inflation
Base year = basis of comparison for all other periods
Calculating:

9. Inflation 2007 CPI = 207.3 2006 CPI = 201.6 207.3-201.6/201.6 =
Very rare cases CPI declines

10. Rule of 70 #of years for a measurement to double
70 ÷ 3 (answer from previous slide) = 23
3% annual interest rate doubles price level in 23yrs

11. Demand-Pull Inflation
Caused by demand
Usually more than economy can handle.
Inflation = rapid and sustained = overissuance $
Resources = fully employed = businesses cannot respond to demand
Too much $ chasing too few goods

12. Cost – Push Inflation a/k/a supply side inflation
i.e. input prices rise, costs more to make, price rises
Per unit production cost = total input cost/units of output
Rising costs squeeze profits
Supply declines, prices rise

13. Stagflation Stagflation = economic condition
rising average price level (inflation)
decrease in Real GDP (recession)
usually accompanied by a rising unemployment rate.
Usually real GDP declines w/falling price level.

14. Hyperinflation Extraordinarily rapid inflation
Devastating to real output and employment
Money becomes worthless
Germany after WWI
Germany’s = one of the worst in history

15. Hurt by Inflation Fixed income: Retirees on pension
Landlords of rent control
Savers:
Real value of dollars declines
Paper assets not enough
i.e. annuities, insurance policies, savings accounts

16. Helped by Inflation Flexible income:
Social Security payments = indexed to CPI
Cola = cost of living adjustments
Debtors:
Fixed interest = interest rate does not change w/inflation

17. Aggregate Supply
Aggregate Supply = total of all goods and services firms are willing/able to supply at each price level in a given period of time.
Short run = aggregate supply curve (SRAS) is upward-sloping showing a direct relationship between price level and real GDP.

18. Aggregate Supply
It is upward because wages/prices slow to change due to contracts. a/k/a sticky wages/prices
Long run = prices completely flexible
supply curve (LRAS) is vertical at the full employment level of real GDP (real output or real national income).

19. Aggregate Demand
Aggregate Demand = total quantity of all goods and services consumers are willing and able to purchase at each price level in a given period of time.
The aggregate demand curve (AD) is downward-sloping showing an inverse relationship between price level and real GDP.

20. Three Effects
The interest rate effect = downward slope of the aggregate demand curve because
price level rises
interest rates (the price of borrowing money) rises
consumers and businesses spend less on interest sensitive purchases i.e. cars, new homes, and physical capital.

21. Three Effects
The wealth effect occurs = rising price level reduces the purchasing power of consumers = lowers consumption
foreign purchases = higher price level in a country = country’s exports higher = reducing demand for the country’s exports in other countries.