INFLATION

Inflation v. Deflation Inflation is a general rise in the level of prices. Deflation is a decline in the level of all prices.

Other terms Disinflation is a slowing of price increases (inflation rate decreases)

More terms Hyperinflation is extreme, rapid, and out of control inflation Classic example in Germany: In 1922, the highest denomination was the 50 thousand Mark. By 1923, the highest denomination was 100 trillion Mark That’s a 1.9 x 10^11% increase!!!

Types of Inflation There are two major types of inflation. Demand-pull inflation is too many dollars, chasing too few goods. Demand-pull inflation is caused by too much aggregate demand P Q D1 D2 S

Types of Inflation Cost-push inflation occurs when the cost of producing goods rises; usually this is an increase in the cost of inputs. This causes aggregate supply to decrease. This is more harmful to the economy because not only does the price level go up, but the output or GDP declines. P Q D S1 S2

Causes of Inflation There are several causes of inflation: Wage-price spiral Government spending

Causes of Inflation The wage-price spiral is when prices rise, causing workers to demand raises to pay the higher prices causing prices to increase again because the workers are paid more money; This continues and we are in a wage-price spiral. This is related to cost-push inflation because wages are paid for the labor input.

Causes of Inflation Government spending too much money causes deficit spending. This is related to demand- pull inflation.

How the economy should work Quantity theory of money or inflation is what Monetarists believe. The money supply should grow at a constant rate to equal the growth of the economy.

Effects of Inflation dollar will buy less or purchasing power decreases Spending habits change interest rates rise people won’t get loans for big ticket items

Effects of Inflation distribution of income is altered lenders hurt and borrowers are helped money paid back is worth less

Effects of Inflation reduces real wages of workers decreases the value of saving dollar is worth less

Measuring Inflation Two ways to measure inflation are CPI and PPI. These are two types of cost of living adjustment or “COLA’s.” They are automatic adjustments to wages each year that takes into account the rate of inflation.

Stagflation Stagflation is a time of high unemployment coupled with high inflation.