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Inflation
(Part 3 – consequences)
Is Inflation Good or Bad?
2.) CPI – measuring Inflation
Inflation:
4.) Causes of Inflation
1.) Inflation Vocabulary
5.) Consequences of Inflation
3.) Problems of CPI
Part 1
Part 2
Part 3
Inflation
Is Inflation Good or Bad?
It’s a monster, but not everyone is hurt.
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High and volatile inflation has economic and social costs.
- If people know it will happen they can protect themselves, but still has problems.
Expected Inflation
5.) Consequences of Inflation
Unexpected Inflation
- This is the one that sucks most.
- Especially when it is volatile 挥发物 it makes it very hard to conduct business.
- People on fixed incomes hurt the most.
- Loans that have interest rates and have inflation expectations built in are affected.
- Also has the same problems as expected inflation but it’s now unexpected!
Vs.
- Your money buys less stuff!Falling purchasing power
Problems:
5.) Consequences of Inflation
- Holding money as cash doesn’t have an interest rate. More trips to the bank may be necessary.
Shoe leather costs
Menu costs - Difficult for firms to change prices often.
Taxes distorted扭曲 - Taxes usually don’t count inflation, and can cause a larger burden 负担.
Inflation redistributes income - Can be unexpected and undesired!
Problems:
5.) Consequences of Inflation
- Holding money as cash doesn’t have an interest rate. More trips to the bank may be necessary.
Shoe leather costs
The idea comes from the old days of having to walk back and forth to the bank a lot, it wore holes in
your shoes.(a type of opportunity cost)
Problems:
5.) Consequences of Inflation
Menu costs - Difficult for firms to change prices often.
Some firms can change prices quickly. (low opportunity
costs to do so.)
Some firms is very costly to change their prices often.
(high opportunity costs to do so.)
Problems:
5.) Consequences of Inflation
Inflation redistributes income - Can be unexpected and undesired!
Not always desirable, sometimes redistributes taking income from poor people and giving more income to rich people.
Overall Inflation redistributes income arbitrarily and can be unexpected or not desired.
5.) Consequences of Inflation
- Some people win – the ones getting the higher prices
(think oil/gas companies)
- Some people lose – the ones paying the higher prices
(think YOU!)
5.) Consequences of Inflation
Inflation Winners:
Debtors
Many firms
Inflation Losers:
Government(sometimes)
Lenders
Some payers
Most savers
Inflation and uncertainty Do I spend today, or
save? Prices going up or not? What is happening to my purchasing power? ARRRGGHH!
5.) Consequences of Inflation
Inflation Winners:
- The ones getting the higher prices.
example:
- oil/gas companies
Debtors - Pay back with less valuable moneyexample:- borrow money from the bank
Many firms
Inflation Losers
Government(sometimes)
- Biggest debtor in the world (Debtors WIN!)- Can get high taxes revenue
5.) Consequences of Inflation
Inflation Winners:Inflation Losers:
- The ones paying the higher prices. Falling real incomes.
example:
- you and me
- fixed incomes
Lenders - Get paid back with inflated dollars. (dollars that are worth less)
example:- banks, creditors
Some payers
Most savers - Saving is losing value over time.
InflationSucks…
To summarize so far…
- a sustained increase in the cost of living or the general price level leading to a fall in the purchasing power of money.
Inflation
- is measured by the annual percentage change in consumer prices.
Rate of Inflation
1.) Inflation Vocabulary
- when the rate of inflation becomes negative.
Deflation
- the value of money becomes worthless.Hyperinflation
- ………………………….hless.Stagflation
- measures the typical consumer’s cost of living with only the typical things that are purchased.
- the main way to measure inflation.
Consumer Price Index (CPI)
1.) Inflation Vocabulary
How the CPI Is Calculated:
- Government surveys consumers to determine what’s in the typical consumer’s “shopping basket.”
2.) CPI – measuring Inflation
1.) Fix the “basket”
- Government then collects data on the prices of all the goods in the basket.
2.) Find the prices
3.) Compute the basket’s cost
-Use the prices to compute the total cost of the basket.
How the CPI Is Calculated:
- The CPI in any year equals:
2.) CPI – measuring Inflation
4.) Choose a base year and compute the index
100 xcost of basket in current year
cost of basket in base year
- The percentage change in the CPI from the preceding period:
5.) Compute the inflation rate
CPI this year – CPI last year
CPI last year
Inflation
ratex 100%=
3.) Problems of CPI
*** The general problem is that CPI tends to overstate the actual increase in the cost of living.
- Introduction of New Goods
- Substitution Bias
- Unmeasured Quality Change
- Discount sales
Different parts of this theory that brings us to the conclusions we will work with:
Classical Dichotomy
Quantity Theory of Money
Neutrality of Money
Velocity of Money (V of Money) - the rate at which money changes hands.
v =P x Y
M
Equation:
Inflation and the Classical Theory
Long Run Aggregate
Supply (LRAS)
Price
level
GDP
LRAS
Y
P1
P2Therefore: With the quantity equation (fisher equation) if Vis stable that means an increase in M just means and increase in P and not Y, so in the long run we just have inflation only.
M x V = P x Y
Inflation and the Classical Theory
MS1
$1000
Value of Money, 1/P
Price Level, P
Quantity of Money
1
¾
½
¼
1
1.33
2
4MD1
EQ
price level
EQ value
of money
A
MS2
$2000
B
Then the value of
money falls,
and P rises.
Suppose the central
bank increases the
money supply.
2.) Money supply – demand diagram
How does this work? Short version:
At the initial P, an increase in MS causes excess supply of money.
People get rid of their excess money by spending it on g&s or by loaning it to others, who spend it. Result: increased demand for goods.
But supply of goods does not increase, so prices must rise.
Result from graph: Increasing MS causes P to rise.
2.) Money supply – demand diagram
Quantity Theory of Money
Price
level
GDP
LRAS
Y
P1
P2
Price
level
GDP
AD
SRAS
PE
LRAS
YN
SRAS1
Y1
P1
The bad kind of inflation because it involves lower output.
2.) Cost-Push
Negative supply shock
4.) Causes of Inflation
2.) Cost-PushReasons:
a.) Input costs rise - Raw material costs rise.
b.) Labor costs rise - Pay more for workers means increased input costs.
c.) Fall in the exchange rate - Raw materials imported
costs rise.
d.) Expectations of inflation
- If inflation is expected, raise prices even higher.
Price
level
GDP
AD
SRAS
PE
LRAS
YN Y1
P1
AD1
The good kind of inflation because it involves more output.
3.) Demand-Pull
4.) Causes of Inflation
3.) Demand-PullReasons:
a.) Growing economy - Demand rising faster then supply can keep up.i.) *wealth effect
b.) Fall in the exchange rate
- Demand internationally rising faster then supply can keep up.
c.) Expectations of inflation
- If inflation is expected, raise prices even higher.
- Your money buys less stuff!Falling purchasing power
Problems:
5.) Consequences of Inflation
- Holding money as cash doesn’t have an interest rate. More trips to the bank may be necessary.
Shoe leather costs
Menu costs - Difficult for firms to change prices often.
Taxes distorted扭曲 - Taxes usually don’t count inflation, and can cause a larger burden 负担.
Inflation redistributes income - Can be unexpected and undesired!
5.) Consequences of Inflation
Inflation Winners:
Debtors
Many firms
Inflation Losers:
Government(sometimes)
Lenders
Some payers
Most savers
Inflation and uncertainty Do I spend today, or
save? Prices going up or not? What is happening to my purchasing power? ARRRGGHH!
The EndThank you