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Effects of Inflation

Effects of Inflation. explain the effects of inflation on households and firms explain the effects of inflation on growth and trade. Inflation and Households. Purchasing power : Inflation reduces purchasing power (get less for same price).

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Effects of Inflation

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  1. Effects of Inflation explain the effects of inflation on households and firms explain the effects of inflation on growth and trade

  2. Inflation and Households • Purchasing power: • Inflation reduces purchasing power (get less for same price). • i.e. family on an income = $100/week, they buy one product worth $5. This means they can purchase 20 of this good. But if the price were to increase to $10 for the product they could now only purchase 10. • Standard of living has declined. • If a households income increases with inflation then the price increases will not hurt their purchasing power. Fixed income households will suffer a decrease in purchasing power.

  3. Inflation and Households • Inflationary expectations: • When we expect inflation to occur, we buy goods and services before we normally would to beat the price rise, but instead help cause inflation.

  4. Inflation and households • To control inflation the RBNZ may rise the OCR. This leads to interest rates increasing, and in turn decreasing consumer spending…..

  5. Interest Rates and Households • Interest rates are the price of money: savers receive interest as the price paid to them by borrowers for the use of their money. • Increase in interest rates: • cost of borrowing increases which will discourage consumers from purchasing goods and services on credit (loan, mortgage, credit card, hire purchase) therefore consumption will decrease. • Increase in return from savings which will encourage people to save, therefore consumption will decrease.

  6. I would like to borrow $100 please MrKrabs, to buy Gary a new bed Ok, I will lend you $100 but in one year you must pay back 6% interest meow

  7. MEANWHILE Prices in bikini bottom are rising at 10%! Who will be better off in a years time, MrKrabs or Spongbob?

  8. Here’s your $106 MrKrabs But…. Prices have rose by !0%, if I wanted to buy a new cash register a year ago I would only have to pay $100, now I have to pay $110

  9. Inflation and Borrowers vs. Lenders • Borrowers will become better off in times when the inflation rate is more than the nominal interest rate. • Example: say you borrow $100 at an interest rate of 6% at a time when prices are rising at a rate of 10%. In one years time you will repay $106. • The lender receives this back, but if they (the lender) wanted to buy the same good you bought for $100 a year ago they must now pay $110 for it (due to 10% inflation) and so cannot afford it now. They could have afforded it at the time you borrowed the money. • The real rate of interest would be -4% (the nominal interest rate – inflation = real interest rate). Therefore making savers worse off than borrowers.

  10. Interest Rates and Households • Decrease in interest rates: • Cost of borrowing decreases which will encourage people to purchase more goods and services on credit, therefore consumption will increase. • Decrease in return from savings which will discourage people to save, therefore consumption will increase.

  11. Firms and Inflation • Firms also get hit by inflation: • Increased costs of resources • Resources cost more to buy profits down. • E.g. materials, fuel. • Firms will either pass increased costs to consumers by increasing price (which can cause a decrease in demand for their product) OR they will keep the price the same and decrease their profits.

  12. Firms and Inflation • Increased demand for wage rises • Firms will feel pressure from unions to pay higher wages if inflation continues to exist. • This reduces their profits and may cause redundancies.

  13. Double hit to firms • The RBNZ will try and minimise the effects of inflations and will increase the OCR causing higher interest rates (more expensive to invest by firms). • Higher interest rates attract Foreign Investment to NZ. • This increases the demand for the $NZ, therefore appreciation of the $NZ.

  14. Export receipts will drop as it becomes more expensive for overseas consumers to buy our exports. • Imported raw materials become relatively cheaper

  15. Growth and Inflation • Growth is an increased amount of GDP being produced each year. • GDP= AD = C + I + G + (X – M) • If the horizontal axis on our AD/AS model changes this effects NZ Growth. • How will inflation effect Growth???

  16. Trade and Inflation • Inflation pushes NZ costs of production up • E.g. a good that costs $100 to make will soon cost $110 to make. • The higher costs of production will then usually be passed onto consumers (our international trading partners). • Our goods become relatively more expensive compared to our international competitors, therefore we lose out international competitiveness. X decreases (decreasing net exports). • Imports now become relatively cheaper so M will increase (decreasing net exports).

  17. Planning: • http://tutor2u.net/economics/content/topics/inflation/costs_of_inflation.htm • http://everything2.com/title/The%2520effects%2520of%2520inflation

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