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Inflation Lecture notes 7 Instructor: MELTEM INCE

Inflation Lecture notes 7 Instructor: MELTEM INCE. Inflation and the Price Level. Inflation is a process in which the price level is rising and money is losing value. Inflation is a rise in the price level, not in the price of a particular commodity.

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Inflation Lecture notes 7 Instructor: MELTEM INCE

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  1. Inflation Lecture notes 7 Instructor: MELTEM INCE

  2. Inflation and the Price Level Inflation is a process in which the price level isrising and money is losing value. Inflation is a rise in the price level, not in theprice of a particular commodity. The inflation rate is the percentage change in the price level. That is, where P1 is the current price level and P0 is last year’s price level, the inflation rate is [(P1 – P0)/P0]  100

  3. Inflation and the Price Level

  4. Causes of Inflation Demand-pull inflation is an inflation thatresults from an initial increase in aggregate demand. • Demand-pull inflation may begin with any factor that increases aggregate demand. • Two factors controlled by the government are increases in the quantity of money and increases in government purchases. • A third possibility is an increase in exports.

  5. Demand-pull Inflation

  6. Cost-push Inflation Cost-push inflation is an inflation that results from an initial increase in costs. • There are two main sources of increased costs • An increase in the money wage rate • An increase in the money price of raw materials, such as oil.

  7. Cost-push Inflation

  8. Effects of Inflation • Higher than anticipated inflation lowers the real wage rate and employers gain at the expense of workers. • Lower than anticipated inflation raises the real wage rate and workers gain at the expense of employers. • Higher than anticipated inflation lowers the real wage rate, increases the quantity of labor demanded, makes jobs easier to find, and lowers the unemployment rate. • Lower than anticipated inflation raises the real wage rate, decreases the quantity of labor demanded, and increases the unemployment rate.

  9. Effects of Inflation Forecasting Inflation • To minimize the costs of incorrectly anticipating inflation, people form rational expectations about the inflation rate. • A rational expectation is one based on all relevant information and the possible forecast, although that does not mean it is always right; to the contrary, it will often be wrong.

  10. Demand vs. Supply Inflation • Demand Inflation is a sustained increase inprices that is preceded by a permanentacceleration of nominal GDP growth. • Supply Inflation is an increase in prices that stems from an increase in business costs not directly related to prior acceleration of nominal GDP growth.

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