1. Inflation
A general increase in prices caused by too much money in the circular flow

2. Imagine you have a job that pays $50 a day
Imagine you have a job that pays $50 a day. You are pretty happy with your job and your ability to pay your bills with your income. At the end of the work day you receive your $50 and stop at the grocery store to buy dinner. When you get to the grocery store, you find out that your can of beeferoni is not $1.09 like it was yesterday, it is now $49. What happened?

3. Types of inflation Demand-Pull Inflation Cost-Push Inflation
Too much spending chasing too few goods
Cost-Push Inflation
Supply shocks – abrupt increases in the cost or raw materials or energy sources

4. Hyperinflation
Radical inflation – money becomes worthless and is no longer used as a median of exchange economic collapse and political chaos
Examples: Germany after the war, after break up of Soviet Union

5. CPI – consumer price index
Indication of inflation calculated by sampling households and monitoring expenditures on specific goods and services
Core CPI takes out food and energy
CPI not perfect – consumption patterns change, doesn’t account for quality and hard to account for new products

6. Downfalls of CPI Quality bias New product bias
What happens when quality changes year to year?
New product bias
What happens when new products aren’t considered in CPI right away? (also price changes)
Discounting and substitution
What happens when we shop in new places?

7. Fixed CPI calculation = 105.5 or 5.5% inflation rate Year
Theatre tickets (quantity)
Cinema tickets (quantity)
Theatre ticket (price)
Cinema ticket (price)
2005 25 12
$40
$15
2006 15 18
$45
$10
(25 Theatre tickets x $45) + (12 Cinema tickets x $10) x 100
(25 Theatre tickets x $40) + (12 Cinema tickets x $15)
= or 5.5% inflation rate

8. An alternative – chain weighted CPI
It implements weight shifting, which means the shift from one product to another due to the changed needs of the consumer.
Suggested as a way for the government to save money

9. Chain weighted CPI calculation
Year
Theatre tickets (quantity)
Cinema tickets (quantity)
Theatre ticket (price)
Cinema ticket (price)
2005 25 12
$40
$15
2006 15 18
$45
$10
(15 Theatre tickets x $45) + (18 Cinema tickets x $10) x 100
(25 Theatre tickets x $40) + (12 Cinema tickets x $15)
= 72.5 or 27.5% deflation

10. Unexpected Inflation
Unexpected inflation imposes costs on many people and benefits others because it arbitrarily redistributes purchasing power
Inflation can reduce the rate of growth of national living standards because individuals and organizations use resources to protect themselves against the uncertainty of future price changes

11. Redistribution Effects
Nominal income – the number of $ received as wages, rent, interest or profits
Real income- measure of the amounts of goods and services nominal income can buy
Real= nominal income / price index
COLA – cost of living adjustment

12. How are different people affected?
Hurts savers and people on fixed incomes
Helps people who borrowed money at a fixed rate

13. MV = PQ Equation of Exchange
M – Quantity of Money in the Economy
V – Velocity of Money
P – Price Level
Q – Total Final Output Produced
Fundamental cause of inflation is a growth of the money supply faster than the growth of goods and services