Definition,
Inflation is defined as the quantitative measure of the rate at which the average price level of a basket of selected goods and services in an economy increases over a period of time.
Inflation is expressed as a percentage.
It indicates a decrease the purchasing power of a nation’s currency.
Inflation can also cause a wage price spiral or even hyperinflation.
Types of inflation
There are two types of inflation
• Demand pull inflation
• Cost push inflation
Demand pull inflation
- It occurs when spending on goods and services drive up the prices of goods and services.
- The aggregate demand is greater than the aggregate supply
- Aggregate demand and means the willingness and the ability of households, firms, government and the foreign sector to buy the new.
- Aggregate supply on the hand means the real gross domestic product(GDP) that firms are willing to produce at each price level.
- Persist in the public and foreign sector reinforces demand full inflation,
- It can also spread across borders.
Asset inflation
This is a type of inflation that occurs in specific industry, and can happen when overall inflation is otherwise low.
Monetizing the debt.
This is the process by which the central bank buys new government debt , thus an increase in the supply of money circulation in the country.
Cost pull inflation
Occurs when the price of inputs increase.
When the price of the factors of production like land and technology increase it reduces the ability of producers to generate output.
Stagflation.
It is the combination of higher inflation, reduced gross domestic product and unemployment.
Cost push inflation.
It is associated with a decrease in the gross domestic product.
Assets.
Assets are everything that is owned by an individual or a firm.
Good inflation.
A small amount inflation is needed and also considered healthy for the economy as the anticipation that price will rise increases the demand for goods and services.
Inflation indexes.
Consumer price index-it’s a measure that examines the weighted average of price in a basket of goods and services which are of primary consumer needs.
Wholesale price index-measures and tracks the changes in the price of goods and services in the stages before the retail level
Revision.
inflation
A sustained increase in the average of all prices of goods and services in an economy
Deflation
A sustained decrease in the average of all prices of goods and services in an economy
What is inflation?
- Inflation is when the prices of most goods and services continue to creep(leo, truon len) upward. When this happens, your standard of living falls. That’s because each dollar buys less, so you have to spend more to get the same goods and services.If inflation is mild (yeu), it can actually spur (thuc day) further economic growth. If prices rise slowly and gradually (dan dan, tu tu), it can encourage (khuyen khich, thuc day) people to buy now and avoid future price increases. This increases demand, driving further economic growth. In this way, a healthy economy can usually sustain (chong do) a 2% inflation rate.
- If inflation is mild (yeu, nhe), it can actually spur (thuc day) further economic growth. If prices rise slowly and gradually (dan dan, tu tu), it can encourage (khuyen khich, thuc day) people to buy now and avoid future price increases. This increases demand, driving further economic growth. In this way, a healthy economy can usually sustain (chong d
Shortened Time Horizons
During the German hyperinflation, workers were paid two or three times a day so that they could buy goods in the morning before prices increased in the afternoon
Speculation
People may be encouraged to withhold resources from the production process, hoping to sell them later at higher prices.
Bracket Creep
Under our progressive tax system, taxes go up when prices rise.
Savings, investment, and work effort decline.
What is the difference between nominal income and real income.
Nominal = income you receive in a particular period
Real income = what you can use for purchasing stuff.
***If you nominal income does not change and there is an increase in the average level of prices….. You cannot buy as much “stuff.”
If the number of dollars you receive every year is always the same, your nominal income doesn’t change- but your real income will rise or fall with price changes.
Another rule
If you put your money into savings and keep it there rather than spending it, and inflation comes along…
your money in savings will not buy as much as it would prior to the wave of inflation that hit.
Money Illusion
Even people whose nominal incomes keep up with inflation often feel oppressed by rising prices.
They feel cheated when they discover that their higher nominal wages don’t buy additional goods.
Uncertainty
One of the most immediate consequences of inflation is uncertainty.
Uncertainties created by changing price levels affect consumption and production decisions.
What Causes Inflation?
Nearly all economists believe that rapid expansion in the supply of money is the cause of inflation.
What happens if incomes go up to keep pace with inflation?
Bracket creep is the movement of taxpayers into higher tax brackets (rates) as nominal incomes grow.
Deflation Dangers
Deflation — a falling price level — might not make people happy either.
Deflation reverses the redistributions caused by inflation. (Example: people today – upside down on their houses.)
Speculations from consumption and production
If you expect prices to rise, it makes sense to buy things now for resale later.
People may be encouraged to withhold resources from the production process, hoping to sell them later at higher price
As such behavior becomes widespread, production declines and unemployment rises.
Measuring Inflation
Measuring inflation serves two purposes:
Gauges the average rate of inflation.
Identifies its principal victims.
Consumer Price Index (CPI)
The CPI is the most common measure of inflation.
The consumer price index (CPI) is a measure (index) of changes in the average price of consumer goods and services.
Price Level
- A weighted average of the prices of all goods and services.
Price Index
A measure of the price level
Consumer Price Index (CPI)
A widely cited index number for the price level; the weighted average of prices of a specific set of goods and services purchased by a typical household.
How to measure rate of inflation
Measuring the Rate of Inflation
Market Basket
Representative bundle of goods and services
Base Year
The point of reference for comparison of prices in other years
Base Year
The year chosen as a point of reference or basis of comparison for prices in other years; a benchmark year.
Consumer Price Index (CPI)
By observing the extent of price increases, we can calculate the inflation rate.
The inflation rate is the annual percentage rate of increase in the average price level.
Changes in Prices
Percentage change in prices =
Current year – later year later year x100
later year
In 2005 the CPI was 195.3; in 2006 the index was 201.6. What was the percentage change in prices from 2005-2006?
Click below for answer.
3.22 %
Here’s a little hint if you forget…C-L/L
CPI determined
-Calculates the inflation rate
-Market basket of goods and services (same each year.)
-Bureau of Labor Statistics determines cost in 85 cities by shopping 184 items.
19,000 stores visited and 60,000 landlords,renters and homeowners surveyed each month
-Statistics released each month.
-Yearly average compiled.
-CPI expressed in base year ’82-84
- Constructing the CPI
- The base period is the time period used for comparative analysis — the basis of indexing, for example, of price changes.
Real-world price indexes
Consumer Price Index (CPI)
Producer Price Index (PPI)
GDP deflator
Personal Consumption Expenditure (PCE)
What is stagflation?
High inflation and high unemployment….
A period during which an economy is experiencing both substantial inflation and either declining or slow growth in output.
Economists used to say this would and could never happen… it did in the 80’s
Paul Volker entered the scene as Fed chairman and held court on monetary policy.. More of this story later…
Inflation rate
= percentage rate of change of a PRICE INDEX
Measuring INFLATION
- Consumer price index (CPI)
- Consumer price index (CPI)
Is a measure (index) of change in the average price of consumer Goods and services.
A supply Shock
A sudden surprise event that increases or decreases output temporarily.
When output is increased (decreased), the price of the good decreases (increases) due to a shift in the supply curve to the right (left)
The two tools of fiscal policy that goverment can use to stabilize an economy
Fiscal policy is the use of government spending and taxation to influence the economy
Facts of Inflation (5)
-no inflationary trend before the 1930s
-persistent inflantory trend since 1930s
-since the Great Depression it has been variable
-money and prices are positively associated
-this and interest rates are positively associated
Demand-Side Inflation
(cause of inflation)
occurs when AD increases and pulls prices up. At a microlevel, this is associated with rising output and falling unemployment
Supply-Side Inflation
(cause of inflation)
occurs when AS declines and pushes prices up, this is associated with falling output and rising unemployment
Moderate Demand-Side Inflation
looks like supply-side inflation
What do we need to determine whether inflation is demand-side or supply-side?
We must know the source of rising prices
The equation of exchange
MV=PQ
M=money supply
V=velocity of circulation
P=price level
Q=output of real GDP
Equation of Exchange:
What does rising V cause?
It cause P to rise faster and alters the relationship between the growth of M and growth of P
Equation of Exchange:
If V is growing rapidly what can it lead to?
Leads to the result of P growing faster than M
Equation of Exchange:
What is rising V associated with?
Associated with periods of rising inflation
Equation for nominal interest rate?
=real interest rate + inflation rate
What are changes in nominal interest rates primarily determined by?
Changes in inflationary expectations
Because future inflation is more important than current inflation
Adaptive expectations
expectations that we form from past experience and modify only gradually as experience unfolds
Rational expectations
expectations that we form by using all available information, relying on past experience but also on the effects of present and future policy actions
Monetary Growth and Interest Rates
-effect on interest rates of a one-shot increase in the money supply
-SR versus the LR effects
-An increase in the money supply can initially lower interest rates, but the resulting increase in prices and output pushes interest rates back up in LR
-effect on interest rates of a continuous increase in the money supply
-in the LR an increase in monetary growth raises the nominal interest rate but not the real interest rate
Ratification of Supply-Side Inflation
results when the government increases the money supply to prevent adverse supply side shocks from raising unemployment
-AD is shifted to counter the effects of AS shifts to leave output and employment unchanged, but at higher prices
Wage/price spiral
occurs when higher prices push wages higher and then higher wages push prices higher, or vice versa. This spiral is sustained by the monetary authorities ratifying the resulting supply side inflation by increasing money supply
AD equation?
AD = C + I + G + X – M
Case for zero inflation?
-inflation causes us to engage in economically unproductive activities
-inflation reduces gains on long term invested capital
-reduces economic growth
-inflation causes price system distortions
Monetarism
prescribes that money supply must expand at a constant rate roughly equal to the long run growth of real GDP.
In other words, monetarists recommend a constant money growth rule
