InflationStandard 5 Notes Part I

Inflation

Inflation- a sustained rise in the level of prices generally or a sustained decrease in purchasing power.

What causes inflation?

Demand-pull inflation- results when total demand rises faster than the production of goods and services

"more money chasing the same amount of goods.“

What causes inflation? Cost-push inflation- results when

increases in the costs of production push up prices.◦ Inputs like labor, land, capital, and

management◦ Wage-price spiral- a cycle that

begins with increased wages, which lead to higher production costs, which in turn result in higher prices, which result in demands for higher wages.

Cost-push Inflation

What is the impact of inflation?

Decreasing Value of the Dollar- people on fixed incomes are hit hard. They do not receive wage increases. EX: People on social security

Increasing Interest Rates- borrowing money becomes more expensive. Credit card payments raise. Consumers buy less items that require borrowing like houses and cars.◦ Ex. Fred wants to buy a car valued at $10,000

Fred saved up for a plan where the interest rate is 5% ($188 a month) Inflation caused interest rates to increase to 10% (now $212 a month Over his 5 yr loan period, Fred will end up paying over $1,425 more for his loan at

the higher rate

Decreasing Real Returns on Savings- if the inflation rate is higher than your interest rate, you can lose money that you are trying to save.

Inflation How is it measured?

◦ Consumer Price Index (CPI)- a measure of changes in the prices of goods and services commonly purchased by consumers.

◦ Producer Price Index (PPI)- a measure of change in wholesale prices

◦ Inflation Rate- the rate of change in prices over a set period of time.

Types of InflationCreeping inflation

Galloping Inflation

Hyperinflation

Deflation

Deflation

GDP

Standard 5

Gross Domestic Product (GDP)

• Market value of all final G/S produced within a nation in a given time period

• To be included, a G/S must be final (intermediate- fabric, final- shirt) and produced within borders

• Calculating GDP:Consumption (C)

+ Investment (I) + Government Spending (G) + Net Exports (Foreign trade, X)

• When GDP is growing, an economy creates more jobs and more business opportunities

• When GDP declines, jobs and more business opportunities become less plentiful

2 Types:• Nominal GDP- stated in the price levels for the year in which the

GDP was measured

• Real GDP- nominal GDP adjusted inflation (for changes in prices)– An estimate of the GDP if prices were to remain constant from year to

year

• If output remained the same, how would a year of falling prices affect nominal GDP? How would it affect real GDP?

• Nominal GDP would fall compared with other years. Real GDP would not change.

What GDP Does Not Measure

• Nonmarket activities (i.e. home childcare or performing one’s own home repairs)

• Underground economy (i.e. illegal- drug dealing and legal- plumber who works for cash)

• Quality of Life (GDP does not show how G/S are distributed- 10%+ of Americans live in poverty)

Just checking…

• If you get paid in cash to baby-sit, mow lawns, or do other chores for neighbors, are you part of the underground economy? Why or why not?

• Yes, if you are required to file taxes and do not report the income to the IRS

• No, if you do report taxable income

How economic value might be assigned to homemaking activities:

• Choose a partner.• Attempt to determine a dollar value for one

adult’s full-time homemaking activities for one year.

• Take notes about the process you use to arrive at that figure.

Business Cycle• A series of periods of expanding and contracting economic

activity• Four Phases:

– Expansion• A period of economic growth (an increase in a nation’s real GDP)

– Peak• The point at which GDP is highest

– Contraction• Sometimes a recession (6 months+) or depression (extended period of

high unemployment and limited business activity)– Trough

• The point at which real GDP and employment stop declining

How economic growth is measured• Real GDP per capita– Real GDP/Total Population– Reflects each person’s share of real GDP– Some people will have more money, others less– Does not measure quality of life

One way to understand business cycles is through demand and supply…

• Aggregate demand- the total amount of G/S that households, businesses, government and foreign purchases will buy at each and every price level

• Aggregate supply- the total amount of G/S that producers will provide at each and every price level

www. classzone.com

Why do Business Cycles Occur?• Business decisions• Changes in interest rates• Consumer expectations• External issues (i.e. Hurricane Katrina)

Business Cycles in U.S. History

• The Great Depression– Real GDP declined by about a third– Sales in some big businesses

declined by as much as 50 percent– 1 in 4 people were unemployed

• The New Deal– Government agencies created– Many Americans were put back to

work– Some trees in Eagle Creek Park

were planted during this time