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Inflation

Inflation. Another economic instability problem. Meaning of Inflation. Is the rise in general piece level. Not necessary that all prices are increasing In periods of inflation, some prices are rising while some are declining

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Inflation

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  1. Inflation Another economic instability problem Alomar_111_10

  2. Meaning of Inflation • Is the rise in general piece level. • Not necessary that all prices are increasing • In periods of inflation, some prices are rising while some are declining • The most important: general price level, and the increase to have an affect Alomar_111_10

  3. Measuring Inflation • Using CPI when price index measures the general level of prices in the economy. CPI year A=(basket yearA)/(basket in base year) X100 • Therefore, inflation rate2000 =CPI2000-CPI1999 X100 CPI1999 Alomar_111_10

  4. Types of Inflation • Demand Pull Inflation: assume that the economy is at its full capacity of production. Assume that total spending is greater than production level… what will happen to price level? Alomar_111_10

  5. Since all resources are fully employed, production cannot respond to this increase in demand. • Therefore, outputs cannot be expanded to meet demand • This excess demand will bid up prices, causing “demand-pull inflation”. • “Too much spending for too few goods” Alomar_111_10

  6. 2. Cost-Push Inflation: • This is an increase in per-unit production costs. • Per-unit production cost = Total input cost / units of outputs • This will reduce profits and reduce outputs firms willing to produce. Alomar_111_10

  7. Thus, the economy’s supply of goods and services declines and the price level rises. • Costs are pushing the price level upward • Sources: supply shocks: increase in costs or raw materials, energy inputs, wages… Alomar_111_10

  8. Redistribution Effects of Inflation • Inflation hurts some, leaves others unaffected • That is, inflation redistributes real income from some to others • Who benefits and who gets hurt? Alomar_111_10

  9. terminology Nominal and real income: Real income = nominal income/price index • Real wage: purchasing power of nominal wage (number of $$ received as wages, rent, interest, or profits) • Some people will be affected more than others as inflation occurs (redistribution effect) Alomar_111_10

  10. The following rule tells us approximately by how much real income will change: %ΔReal in Income = %Δ in nominal income - %Δ in price level • Anticipation and the effect of inflation? Alomar_111_10

  11. Who is Affected by Inflation? Unanticipated inflation hurts: • Fixed income receivers • Savers • Creditors • Who is Unaffected by Inflation? • Flexible income receivers • Debtors Alomar_111_10

  12. Anticipated Inflation • The redistribution effects of inflation are less sever or can be eliminated when people can expect inflation and can adjust their nominal incomes to reflect the expected price-level increases. • Save more now (consume less) Alomar_111_10

  13. Hyperinflation • Is an extremely high rate of inflation. • Agents expect inflation rate to even gets higher, leading them to “spend now”. • May cause economic collapse • Uncertainty about future prices Alomar_111_10

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