Inflation

INFLATION

INFLATION:A general and ongoing rise in the

level of prices in an economy.

AVERAGE PRICE OF MILK IN THE USA:

.501.502.002.503.003.50

4.004.50

01950 1960 1970 1980 1990 2000 2010 Today

INFLATION:Inflation does not mean that all prices rise the same amount.

It does mean that pressure for price increases reaches across most markets,

not only one.

Not just in one market… but in MOST markets.

INFLATION:Unlike the price changes we saw with the supply & demand models, price changes

due to inflation are not a one time event. If inflation happened for one year and

then stopped, it wouldn’t be called inflation any more.

INFLATION RATE:The rate at which the general level of

prices for goods and services is rising, and, subsequently, purchasing power is falling.

inflat

ion

rate

(%)

INFLATION RATE:The rate at which the general level of

prices for goods and services is rising, and, subsequently, purchasing power is falling.

inflat

ion

rate

(%)

BASKET OF GOODS & SERVICES:

To calculate the inflation rate, economists look at a “basket of goods and services.” This is a hypothetical group of different items, with specified quantities of each one, used as a basis for calculation how

price level changes over time.

BASKET OF GOODS & SERVICES:

When conceptualizing a basket of goods, it is best to imagine a shopping basket. The basket

contains everyday products such as food, clothing, furniture and financial services. As the products in the basket increase or decrease in price, the overall value of the basket changes. The value of the basket each year determines

the inflation rate for that period.

CONSUMER PRICE INDEX (CPI):

The “basket of goods and services” is used to calculate a

consumer price index. CPI shows us how expensive goods and services are in a selected area.

Observing change in the CPI is the most common way to generate an inflation rate.

CONSUMER PRICE INDEX (CPI):

What’s in the “basket”?

CONSUMER PRICE INDEX (CPI):

Make a list of 5 cities you think you might like to live in.

CONSUMER PRICE INDEX (CPI):

Compare CPI in the cities you selected. A higher CPI number indicates that goods and services cost more in that location.

(Link can be found below slides )

INFLATION IS HARMFUL……because as inflation rates go up, the purchasing power of our money goes

down. This means consumers can buy lesswith their money than they could in the past. Inflation

BUT INFLATION IS GOOD……because a small amount of inflation is a sign that the economy is growing. Typically, growing nations try to maintain a steady

inflation rate of 2% per year.

A COMMON PROBLEM IS……when wages don’t rise at the same rate

inflation is rising at. Normally, in locations with

expensive goods, average wages of employees are high enough to purchase those goods. For

example, a doctor in Tokyo (an expensive city) will have a

higher wage than a doctor in Lansing (my tiny hometown).

DEFLATIONA decrease in the general price level of

goods and services. Deflation occurs when the inflation rate falls below 0% (a

negative inflation rate).

Increases above 0% (inflation)

Decreases below 0% (deflation)

DEFLATIONTo an Economist, Deflation is worse than Inflation (as long as that Inflation isn't too

high!). Deflation causes falling profits, closing factories, shrinking employment and incomes, and increasing defaults on

loans by companies and individuals.

HYPERINFLATIONHyperinflation occurs when a country

experiences very high and usually accelerating rates of inflation, rapidly

eroding the value of the local currency.

“Hyperinflation makes grocery shopping barrels of fun!”

In Germany, 1922, a period of severe hyperinflation began. There were a few causes: namely, the German government had printed an excessive amount of new bills, and reparations placed on Germany after losing WW1 caused the German currency to lose its value

against other currencies.

Famous examples of hyperinflation…

In Zimbabwe, 2008, there was a land-reform policy that took property from white landowners to

redistribute to the public. The government instability that followed caused people to lose faith in the value

of the currency, and rapid inflation took place.

Famous examples of hyperinflation…