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Inflation `

Inflation `. Second evil of society. Inflation and Deflation. Inflation A sustained increase in the average of all prices of goods and services in an economy Deflation A sustained decrease in the average of all prices of goods and services in an economy.

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Inflation `

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  1. Inflation ` Second evil of society

  2. Inflation and Deflation Inflation A sustained increase in the average of all prices of goods and services in an economy Deflation A sustained decrease in the average of all prices of goods and services in an economy

  3. Inflation…is bad…is bad..is bad! What is inflation? A continuing rise in the average level ofprices.(it costs more to purchase the typical “bundle” of goods and services that is produced or consumed or both.) Bottom line: Too many $$$$ chasing too few goods.

  4. The CPI is based on what it costs an average family to live. • Just think… Inflation enables us to live in more expensive neighborhoods without having to move

  5. Inflation is bad… see??? Shortened Time Horizons • During the German hyperinflation, workers were paid two or three times a day so that they could buy goods in the morning before prices increased in the afternoon. Speculation People may be encouraged to withhold resources from the production process, hoping to sell them later at higher prices. Bracket Creep • Under our progressive tax system, taxes go up when prices rise. • Savings, investment, and work effort decline.

  6. Inflation discussion • Notice we said an increase in the Average Level of prices. Not a change in any specific price… • Statisticians calculate the average then look for changes in the average. The Consumer Price Index for All Urban Consumers (CPI-U) decreased 0.4 percent in August, before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. The August level of 219.086 (1982-84=100) was 5.4 percent higher than in August 2007. • A decline in average prices = deflation. • Relative price means an increase in the price of apples (relative to other fruits) apples cost more than pears. • Inflation does not makeALL persons worse off. .

  7. Who wins? Who loose? Winners: • Borrowers • Producers(in short run) Loosers: • Lenders • Savers

  8. Nominal Income vs. Real Income • What is the difference between nominal income and real income. Nominal = income you receive in a particular period Real income = what you can use for purchasing stuff. ***If your nominal income does not change and there is an increase in the average level of prices….. You cannot buy as much “stuff.” If the number of dollars you receive every year is always the same, your nominal income doesn’t change- but your real income will rise or fall with price changes.

  9. Raise vs inflation If you get a raise for 4% and inflation is 5% ….. You do the math. Your increase in income will not cover the increase in prices.

  10. Another rule: • If you put your money into savings and keep it there rather than spending it, and inflation comes along… • your money in savings will not buy as much as it would prior to the wave of inflation that hit.

  11. Uncertainty and Misconception Money Illusion • Even people whose nominal incomes keep up with inflation often feel oppressed by rising prices. • They feel cheated when they discover that their higher nominal wages don’t buy additional goods. Uncertainty • One of the most immediate consequences of inflation is uncertainty. • Uncertainties created by changing price levels affect consumption and production decisions.

  12. Inflation discussion Uncertainty on the part of the consumer in trying to outguess the price of goods and services. If consumers or producers postpone or cancel their expenditure plans, the demand for g & s will fall. Eventually production falls, and unemployment occurs… • What Causes Inflation? • Nearly all economists believe that rapid expansion in the supply of money is the cause of inflation.

  13. Measuring Inflation Measuring inflation serves two purposes: • Gauges the average rate of inflation. • Identifies its principal victims. • Consumer Price Index (CPI) • The CPI is the most common measure of inflation. • The consumer price index(CPI) is a measure (index) of changes in the average price of consumer goods and services.

  14. Macroeconomic Measures - Prices • Price Level - A weighted average of the prices of all goods and services. • Price Index - A measure of the price level. • Consumer Price Index (CPI) - A widely cited index number for the price level; the weighted average of prices of a specific set of goods and services purchased by a typical household.

  15. How to measure rate of inflation Measuring the Rate of Inflation • Market Basket • Representative bundle of goods and services • Base Year • The point of reference for comparison of prices in other years

  16. Macroeconomic Measures - Prices Base Year - The year chosen as a point of reference or basis of comparison for prices in other years; a benchmark year. (82-84)

  17. Computing the Consumer Price Index

  18. Consumer Price Index (CPI) • By observing the extent of price increases, we can calculate the inflation rate. • The inflation rate is the annual percentage rate of increase in theaverage price level.

  19. Changes in Prices Percentage change in prices = Current year - later year x100 later year In 2005 the CPI was 195.3; in 2006 the index was 201.6. What was the percentage change in prices from 2005-2006? Click below for answer. 3.22 % Here’s a little hint if you forget…C-L/L

  20. CPI determined • Calculates the inflation rate • Market basket of goods andservices (same each year.) • Bureau of Labor Statistics determines cost in 85 cities by shopping 184 items. • 19,000 stores visited and 60,000 landlords, renters and homeowners surveyed each month • Statistics released each month.(3.15- .7%) • Yearly average compiled. • CPI expressed in base year ’82-84 Constructing the CPI • The base period is the time period used for comparative analysis — the basis of indexing, for example, of price changes.

  21. What is the difference? So………if it cost you $225 in 2002 to buy the same bundle of goods that you bought in 1983, you would be paying 225% more for the same “stuff.” Look at the inflationary costs of: cars, health care, housing, (house 4 bedrooms, 2 baths, in Highland Park in 1960 cost approximately $30,000.) (Today?????)

  22. Four Bedrooms, two bathrooms, often with a pool House in Plano, 1960. $40,000

  23. Calculations Rate of Inflation = % of PI(price index) from one year to the next. When prices are rising, on average, the price index will rise. i = This year’s PI – Last year’s PI Last year’s PI x100 If price index this year was 220 compared to 200 last year, the inflation rate would equal 10% 220 – 200 200 x 100 = 10 Formula hint: c-l/l x 100 (current-last/last x 100)

  24. Let’s try another calculation In 2008 – CPI measured 215.3 In 2004 – CPI measured 188.9 What was the rate of inflation from 04 – 08? Ans. 13.9

  25. Is there a safety shield against inflation? Answer: not much!!! But Congress has passed the Cost-of-living adjustment (COLA) provision for those receiving Social Security Checks. Checks are indexed each January…in the amount equal to inflation the previous year. If inflation was 3% then the checks are adjusted accordingly. Unions also negotiate for this COLA in their pay proposals…

  26. Bankers in business to make a profit. Some bankers build in that same philosophy- Adjustable-rate mortgage (ARM) stipulates an interest rate that changes during the term of the loan. Actually, banks build the inflation factor into alltheir loans…the number of points depends on many variables we will discuss later. • The real interest rate is the nominal interest rate minus the anticipated inflation rate.

  27. Ways to measure inflation! • Real-world price indexes • Consumer Price Index (CPI) • Producer Price Index (PPI) • GDP deflator • Personal Consumption Expenditure (PCE)

  28. What is stagflation? High inflation and high unemployment…. A period during which an economy is experiencing both substantial inflation and either declining or slow growth in output. Economists used to say this would and could never happen… it did in the 80’s Paul Volker entered the scene as Fed chairman and held court on monetary policy.. More of this story later…

  29. Remember…………..too many $$$ chasing too few goods…. Best street definition for inflation.

  30. CAUSES of inflation • 1. Demand pull (too much aggregate demand and not enough aggregate supply. • Cost Push (production costs rise) supply decreases… S1 S S D1 D D

  31. Still another way to test the health of the U.S. economy The GDP Deflator…. The broadest price index and covers all output including consumer goods, investment goods and government services. (C+I+G) The GDP deflator isn’t a pure measure of price change. Its value reflects both price changes AND market responses to those price changes as reflected in new expenditure patterns. The GDP deflator typically registers a lower inflation rate than CPI and the government watchdogs use this barometer more readily than current CPI

  32. Bottom Line CPIis designed to measure the impact of price changes on the cost of a typical bundle of goods purchased by households(remember, market basket and only for urban purchasers.) GDP deflator is a broader price index and is designed to measure the change in the average price of the market basket of goods included in GDP (in addition to consumer goods it includes capital goods, & g & s by government.) CPI measures money income of consumers in relation to rising prices (only consumer goods.) GDP deflator measures economy wide inflation- more g & s included in measurement.

  33. PCE • More accurate than CPI • Quantifies changing expenditure patterns for consumers. • Is a weighted measure • Doesn’t always have same items calculated • BEA uses continually updated surveys of consumer purchases to determine index • Federal Reserve uses this measure for their predictions and assessments. PERSONAL CONSUMPTION EXPENDITURE

  34. What really is the goal of fiscal and monetary planners? The CPI’s market basket of goods and services was overhauled in 1998. Price Stability….. • Major changes in the general level of prices indicate upsets in the economic system. • Prices act as allocators of economic goods, they are the mechanism that determines the answer to the three basic questions, What, How and For Whom. • Prices act as the basic force in a capitalistic economy 

  35. What does a pair of Nike shoes cost compared to a pair of Keds?

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