Inflation

1. Inflation Frederick University 2014

2. Definition A process of irreversible increase in the overall price level, involving a change in relative prices

3. Typology • According to the form – open and hidden • According to the rate of price growth – moderate, galloping, hyperinflation • According to expectations anticipated and unanticipated • According to source – driven by MS or MD, byAS

4. Demand pull inflation CPI AD AD’ Y

5. Supply push inflation CPI AD AS AS’ stagflation Y

6. Measurement • GDP deflator • Consumer Price Index (CPI)

7. GDP deflator • Nominal GDP – GDP at current prices • Real GDP – GDP at constant prices (base year prices – chosen year) • Index – the change in the value of an indicator compared to its previous level, taken as a base (= 100) • GDP deflator = (Nominal GDP: Real GDP) х 100 GDP deflator is a current year weighted index

8. Consumer Price Index • Consumer basket • Relative shares of goods in the consumer basket - g • CPI = [(P1A/ P0A)x g0A + (P1B/P0B)x g0B]x 100 • Rate of inflation = [(CPI – 100)/100]x 100% • CPI is a base year weighted index

9. There are two goods in the economy – movies and wine Р of movies in 2010 г. = €5. Р of winein 2010 г. = €4. Qof movies in 2010 г. = 400 Qof wine in 2010 г. = 2000 The cost of consumer basket = 400 x € 5 + 2000 x €4 = =€ 10000 € 2000 out of these €10000 were spent on movies. This makes 20% or 0.2 of all money spent on movies. Thus, the relative weight (g) of moviesin 2010 = 0.20 g of wine = 0.80 Р of movies in 2011 = €8 Р of wine in 2011 = €3 CPI = [(8/5) х 0.20 + (3/ 4) x 0.80) x 100 = 93 Rate of inflation = = (93 -100)/100 x 100% = = -7% If the CPI were above 100, the rate of inflation would have been positive. CPI an example

10. The Phillips curve LRPC Rate of inflation Z’ W’ SRPC’ Z SRPC1 W V U U’ U*