1. Unit 2 Outline Module 1: A Market System Module 2: Demand and Supply Model Module 3: Inflation

2. Module 3 Inflation Consumer Price Index Hyperinflation Money Supply Interest Rates

3. Module 2: Demand and Supply Model Learning Intentions Define inflation, money supply, deflation, hyperinflation Discuss why inflation results from rapid growth in the money supply

4. Auction in the Land of the Hungry Our GDP (gross domestic product) is two chocolates. In our mixed market economy, we auction off products in a marketplace. Year Price of Chocolate 1 Average Price of a Chocolate 2015 2016 2017

5. Auction in the Land of the Hungry Our GDP (gross domestic product) is two chocolates. In our mixed market economy, we auction off products in a marketplace. Year Price of Chocolate 1 Average Price of a Chocolate 2015 2016 2017

6. Price Stability Price stability is when your money retains its value over time. This is important if you want to save your money to buy something later, for example. Imagine how you would feel if you had saved $30 to buy a shirt, only to find that the price had risen to $35 when you got to the shop. Then, when you went back with $35, the price had gone up to $38. Fortunately, prices don’t usually rise that quickly!

7. Price Stability How do we know if prices are stable? We can measure price changes! How do we measure price changes? We use something called a “consumer price index” or a CPI.

8. Price Stability What is the CPI? The CPI measures the average change in the retail price of a basket of goods and services that represent a high proportion of spending by metropolitan households. The basket includes food, clothing, housing, transportation, recreation, financial and insurance services, communication, alcohol, health, education. The total price of the basket is periodically checked to see how much prices are rising (or falling, in rare case).

9. Inflation Inflation is a rise in the level of prices paid for goods and services over time. -Inflation does not refer to a price rise for just one item (e.g. icypoles). Instead, inflation describes a situation where prices rise for a wide range of goods and services. Hyperinflation is an extreme situation where prices rise very quickly. Deflation describes prices falling over a period of time. It may result from low demand for goods and services, which forces companies to sell their products at cheaper prices.

10. Inflation Prices are said to be stable if, on average, they neither increase (as in periods of inflation) nor decrease (as in periods of deflation) over time. For example, if $50 can buy roughly the same “shopping basket” as it could one or two years previously, then we can say that the general price level is stable.

11. Calculating Inflation Annual Inflation Rate = CPI Year1 - CPI Year2 x 100 CPI Year1 Example Calculation Annual Inflation Rate = 99.2 – 100.4 x 100 99.2 = 1.2 x 100 99.2 = 1.21% YearCPI 2010-1199.2 2011-12100.4 2012-13102.8

12. Inflation Trends and Goals One of the Australian government’s key economic aims is to achieve the goal of low inflation(also called stability of the currency). The Reserve Bank of Australia (RBA) defines low inflation as “a desirable situation where inflation is slow and general prices are rising by an average of around 2-3% a year.”

13. Inflation Trends and Goals Why 2 to 3%? Inflation below 2-3% could: Weaken the distribution of income Undermine international competitiveness in trade Weaken living standards Inflation above 2-3% could: Lead to slow economic growth (because resources are not being fully used)

14. Inflation Trends and Goals In 2007-08 inflation was higher than the RBA’s target because the economy was operating near its productive capacity. In 2008-09 inflation slowed due to the ongoing effects of the Global Financial Crisis.

15. A case of hyperinflation Hyperinflation impacts badly on people’s wellbeing and living standards. Imagine what happened to the purchasing power of money in the space of just a few hours or days in Hungary in 1946 or Zimbabwe in 2008.

16. A case of hyperinflation In July 2015, 35 quadrillion Zimbabwean dollars equalled US$1. How did this happen? Government printed money to finance wars. Government mismanaged the economy: Spent significantly money than it earned Printed more money to grow the money supply Government reallocated land from white people to the local population. However, the local population did not have farming knowledge and were unable to produce enough crops for food and exports. https://www.youtube.com/watch?v=4d1WRpEl3vw

17. Factors affecting Australia’s inflation rate There are two main types of factors that can affect Australia’s inflation rate: 1.Strong demand-side conditions can cause demand inflation; and 2.Less favourable supply-side conditions can cause cost inflation.

18. Factors affecting Australia’s inflation rate 1. Demand Side Conditions Demand-side factors are influences on the level of economic activity and spending. Changes in these factors might cause demand, and hence inflation, to become stronger or weaker. Examples include: Household income Consumer and business confidence Low interest rates Low taxes Higher government spending

19. Factors affecting Australia’s inflation rate 1. Supply Side Conditions Supply-side factors are influences that might have either favourable or unfavourable impacts on the levels of production and prices. Examples include: Increased wages paid to workers Reduced labour productivity (e.g. outdated equipment causes efficiency of production to decrease) Higher taxes

20. Policies to achieve the goal of low inflation Low inflation can be achieved by slowing: Demand inflation; and / or Cost inflation We are only going to study the demand-side policies. Two methods of impacting demand and cost inflation: 1.Monetary Policy 2.Fiscal Policy

21. Policies to achieve the goal of low inflation Summary Policy TypeMonetaryFiscal Who carries out the policy? Central Bank (i.e. Reserve Bank of Australia) Government What can they change? Interest rates Money supply Government spending Taxation How can they reduce inflation? Increase interest rates to slow spending Reduce government spending Increase taxes

22. Policies to achieve the goal of low inflation Contractionary monetary policy Monetary policy mainly involves the Reserve Bank of Australia (RBA) changing interest rates as a way of affecting the level of national spending (i.e. aggregate demand) and economic activity. Interest rates are what banks pay on savings or charge on credit. Contractionary monetary policy refers to rises in interest rates set by the RBA designed to help slow spending, and thus reduce shortages of goods and services and thus slow inflation. interest rate   spending   aggregate demand   inflation

23. Policies to achieve the goal of low inflation Contractionary fiscal policy Fiscal policy mainly involves the government changing taxes and spending as a way of affecting the level of national spending (i.e. aggregate demand) and economic activity. Contractionary fiscal policy refers to rises in tax (which reduces consumption and investment) and reduction in government spending.  taxes +  gov spending   aggregate demand   inflation

24. The Inflation Game Explore the Inflation Island Game: See how people react to inflation and deflation, and how the scenery changes. Test your knowledge and try to identify the different inflation scenarios. https://www.ecb.europa.eu/ecb/educational/infla tionisland/html/inflation_island.swf?width=1000& height=750&lang=ENhttps://www.ecb.europa.eu/ecb/educational/infla tionisland/html/inflation_island.swf?width=1000& height=750&lang=EN

25. Monetary Policy Game Explore the Inflation Island Game: See how people react to inflation and deflation, and how the scenery changes. Test your knowledge and try to identify the different inflation scenarios. https://www.ecb.europa.eu/ecb/educational/infla tionisland/html/inflation_island.swf?width=1000& height=750&lang=ENhttps://www.ecb.europa.eu/ecb/educational/infla tionisland/html/inflation_island.swf?width=1000& height=750&lang=EN Explore the Monetary Policy Game https://www.ecb.europa.eu/ecb/educational/econ omia/html/index.swf?width=1000&height=750&l anguage=en https://www.ecb.europa.eu/ecb/educational/econ omia/html/index.swf?width=1000&height=750&l anguage=en