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Inflation. Chapter 14. Impact & Measurement. If you were to ask a worker what he wants from his job, what might you expect the answer to be? More pay?. Does more pay mean more wealth? What effect would rising prices of goods and services have on a person’s pay?. Inflation:.
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Inflation Chapter 14
If you were to ask a worker what he wants from his job, what might you expect the answer to be? • More pay?
Does more pay mean more wealth? What effect would rising prices of goods and services have on a person’s pay?
Inflation: • a sustained rise in the average price level. Note: Some prices may go down.
Hyperinflation • Very rapid inflation • Example Zimbabwe. • 2002 April Z$120 to US $1 • 2002 December Z$6200 to US $1 • 2005 Z$25000 to US $1
Inflation Winners Losers • Pension fund holder/former employer of retirees • Borrowers • Financial institutions • Persons on fixed income (pensions) • Creditors • Savers –inflation rate is higher than interest rate. • Consumers
Everyone really loses. • Loss of • Confidence in the economy • Confidence in the government • Desire to maintain work ethic • Regard for thrift and saving
GDP Deflator • Adjusts inflation to measure real growth in the economy. • Measures GDP against a base year.
Problem with GDP Deflator • Measures changes in prices of all goods. • Some prices rise, some fall. • Example: Price of military hardware goes up, price of basic necessities and other items remain stable, the GDP deflator will still rise. • You don’t want to raise the pay for military hardware builders because they were the cause of the inflation in the first place. That would further increase inflation.
Consumer Price Index • Measures changes in the prices that affect a selected market basket of goods and services. (400 goods & services) • Uses a base period from which to compare prices. See figure 14.1 page 286. • (Recent CPI – Earlier CPI/Earlier CPI) X 100 = Rate of inflation • Calculate from 1993 – 2007 • Figure out purchasing power: nominal earnings divided by CPI for that year. • How much has the purchasing power changed from 1993 to present?
Indexing • Tying present wages and prices to some adjustment figure to maintain a balance between real wages and real prices.
Limitations of the CPI • Assumes people buy the same “market basket” month after month. • Does not consider quality changes. (Improvements in tvs/ cell phones, computers) • Ignores the law of demand. (Demand drops as prices increase; CPI assumes consumers keep buying in same quantities.)
Causes & Cures Of Inflation
Inflation has a scary tendency to rise rapidly. • Start slowly but then accelerate. • Prices can double or triple on a daily basis. • Example: Germany’s Weimar Republic.
Two key variables determine prices. • What are they? • Demand • Supply
Supply & Demand Curves • See graphs p. 288-289.
Two Possible Causes of Inflation • 1. Decrease in the nation’s supply of goods and services • 2. Increase in the nation’s demand for goods and services
Cost-Push Inflation: • Business firms begin the inflationary process by charging higher prices (shifting total supply curve to the right). • Workers want increased wages to pay the higher prices. • Businesses raise prices to pay the higher wages. • Workers want higher wages. • Cost-Push Inflationary Spiral • Fails to explain the cause of sustained inflation • Money supply has to keep increasing for cost-push to happen.
Demand-Pull Inflation: • Inflation begins with an increase in demand. • Consumers begin demanding more goods and services. • Shift rightward in demand curve (price increase). • Prices lead to increased wages. • Higher production costs due to higher wages passed to consumers in the form of even higher prices. • Consumers demand higher wages, etc. • Demand-Pull Inflationary Spiral
Money Growth: The Root Cause of Inflation • Does it really matter what the cause is? • The continual increase in the money supply keeps the price level going up. • Rising prices are really just a SYMPTOM of inflation, not actually inflation itself. • Inflation CAUSES a rise in prices.
Inflation is an increase in the supply of money, which is not driven by growth in production.
Cures for Inflation • How people try to cure inflation depends on their view of what causes it.
Wage-Price Controls (Cost-Push cause) • Make it illegal to raise prices and wages. (Freeze the total supply and total demand curves.) • Cannot work if government continues to increase the money supply. • Demand for goods and services continue to increase, but businesses have no ability to meet the demand. • Result is losses of profit and/or development of a black market, selling for higher prices. • Price controls create an artificial shortage for a product. • A free market would allow prices to rise in response to demand and an increase in production to meet that demand. • Economically dangerous – Put a lid on a boiling pot without turning down the heat.
Limitation of Money Creation • If increases in money supply is the cause, then quantity of money being created should be decreased to lower/eliminate inflation.
Bolivian example: • 1985 inflation was 25000% per year. Prices changed by the minute. • In August 1985, the Bolivian president announced that government would stop creating money. It stopped borrowing to pay its bills. • Within two months inflation was at 20% per year.
“Just when I thought I could make ends meet, someone moved the ends.”
Christians want to support policies to curb inflation, but make sure the policies don’t have UNINTENDED CONSEQUENCES.
