Inflation

Inflation & Types

 Inflation
 General increase in prices

Types
1. Creeping – when inflation stays low for a long
time
2. Chronic – when inflation steadily increases
for a long time
Types cont.
3. Hyper- inflation
– worst type, out of control
- could go up to 500% a month
- leads to economic collapse
Causes of Inflation
 Quantity theory – too much money in
the economy causes inflation
Causes of Inflation
Growth of the Money Supply

As more dollars enter the money

supply in the U.S., the value of that
dollar or it’s purchasing power (the
amount it can buy) is less. So to
keep prices “stable”, the money
supply should increase at the same
rate as the economy is growing.

- Note - There are more ways to

increase the money supply than just
printing new money.
 Demand-pull Theory – when demand for
goods/services exceeds existing supplies

 Cost push theory – when producers raise

prices to meet increased costs, leads to
wage price spiral.
Causes of Inflation
2. Changes in Aggregate Supply—
changes in the total amount of goods
and services produced throughout the
economy.
 Cost Push Inflation—When producers
raise prices to cover higher resources
costs.
 Producers must raise prices in order to
cover their higher costs.
 If they do not do this, then their profits are
reduced or even eliminated!
 Must be careful not to raise prices too high.
 Causes of Inflation
Example-
1)If there is low unemployment (such as in expansion
or peak), companies must offer higher wages to
attract workers to their open positions and to keep
their own workers from looking elsewhere.
2)However, this increases companies’ costs.
Therefore the must raise the price of their products
to keep there profits up.
3) If prices are higher across most products
(inflation), then employers must raise wages again
so that their employees’ wages buy as much as it
did the year before.
4) But wait…the companies’ costs went up again so
they raise the price of their products again.
5) And this continues on and on in an effect known as
The Wage-Price Spiral
Effects
 Purchasing Power
 Ability to purchase goods & services

 As inflation increases purchasing power

decreases
Effects
 Purchasing Power
 Ability to purchase goods & services

 As inflation increases purchasing power

decreases
Effects on Purchasing
Power
 Decreased Purchasing Power—
 The decreasing value of the dollar falls and it
buys less “stuff”.
 It hurts people on fixed incomes (retirees).
 Many labor contracts have built in (COLA)
Effects on Income
 Decreased Value of Real Wages—when
the value of workers wages fail to keep
pace with rising prices.
 $20,000 per year in 1979
 $40,000 per year today
 Adjusted for inflation = the same $ today.
Effects on Interest Rates
 Increased Interest Rates— High unexpected
rates of inflation cause banks to raise interest
rates. High interest rates can decrease consumer
and business spending. Ex. Cars, houses etc.
 Decreased Saving and Investing—Ex. Bank
yield on savings 5% and inflation rate of 7%. Net
loss of 2% per year! Inflation hurts savers,
lenders. (however, it helps borrowers and debtors
occassionally)
 Increased Production Costs—Inflation
increases businesses costs of production.
Inflation
 Deflation—A decrease in the average
price level of all goods and services in an
economy.
 Note: Aggregate demand decreases more
rapidly than aggregate supply.(Less people are
chasing the same amount of goods and
services).
 Ex. The Great Depression
Concerns
 Hard to anticipate the costs of
goods/services
 Lose money on investments
 Struggle if on a fixed income
 Who would most likely benefit from an
unexpected 10% inflation rate?
a. Alex who has $5000 in a savings account
b. Maria, who has $5000 life insurance
policy
c. John, who loaned Angelica $5000 last
year
d. Angelica, who borrowed $5000 last year
Measuring Inflation
 Measuring Inflation—when
economists measure the changes in
the average price level of
goods/services in nation.
 The two measuring tools that
economists use are
1) CPI (Consumer Price Index)
2) PPI (Producer Price Index)
Measuring Inflation
 Consumer Price Index (CPI)—is a
measure of the average change over time
in the price of a fixed group of products.
 Reported monthly
 Reported against a fixed period (or base) time
period—currently 1982-1984.
 Market basket—representative sample of
consumer goods. Food, clothing, housing,
utilities, entertainment, transportation, health
care. Measured each month in $.
 How much did it change? = CPI
Measuring Inflation
Calculating CPI
CPI = weighted current price x 100
weighted base period price
Example = $3.00 (loaf of bread in 2017) X 100
$1.32 (loaf of bread in 1983)
CPI 2017 = 227.3
Or

Access this link from the BLS (U.S.

Bureau of Labor Statistics
CPI Inflation Calculator
Inflation Rate
 Inflation Rate—the monthly or yearly %
change in prices.
The CPI is a tool that is used to calculate
Ex.Inflation rate= (CPI year A – CPI year B) x
100
CPI year B
Ex.Inflation Rate 145 – 140 x 100 = 3.57
140
Inflation Rate 3.57%
Inflation Rate
Core Inflation Rate – The inflation rate
excluding effects of food and energy prices.
Question: Why take it out?
Answer: Is a better indicator of long term
inflation because it takes out products that
frequently experience volatile price
changes due to foreign government and
business decisions as well as unexpected
short term crisises (i.e. drought,
hurricane).
Measuring Inflation
 Hyperinflation—is the worst kind of
inflation; it is a situation where inflation is
increasing at a rate of several hundred %
per year.
 Germany after WW 1; Germany printed
more money and by 1923, it took 4.2 trillion
marks to equal $1!!!! Check out this link for
more information on this history making event!
Hyperinflation in Germany 1923
Measuring Inflation
 Producer Price Index (PPI)—is a
measure of the average change over time
in the prices of goods and services bought
by producers.
 Prices are based on some 3,200 different
products.
 The current base year is 1982.