Inflation Is a dollar today worth more or less than a dollar tomorrow?

Example – Movie Box Office Top 5 grossing films of all-time Actual receipts 1. Avatar (09) 2. Titanic (97) 3. Dark Knight (08) 4. Star Wars (77) 5. Shrek 2 (04) 6. ET (82) Others include Pirates, recent Star Wars, Spider Man & Transformers vs Titanic, Jaws, Dr. Zhivago, Jungle Book & Snow White. Top 5 Grossing Films of all-time Adjusted Receipts Gone With The Wind (39) Star Wars (77) Sound of Music (65) ET (82) 10 Commandments (56)

Aggregates Aggregate = The total market Aggregate Demand Total amount of goods & services demanded. Aggregate Supply Total amount of goods & services supplied.

Price levels Given aggregate supply & demand, there is a price level for an economy. Inflation price levels increase Aggregate demand > aggregate supply Deflation Price levels decrease Aggregate demand < aggregate supply

Causes of Inflation 2 types Demand-pull inflation Aggregate demand > productive capacity Causes include increases in money supply or credit. Cost-push Prices increased by producers to cover higher costs of production. Supply shocks such as changes in oil prices, crop failures & natural disasters.

Inflation & Expectations Consumers Expect future inflation Buy now. Expect low inflation Delay purchases. Producers Expect inflation Raise prices.

Measuring Inflation CPI – Consumer Price Index Market basket of goods CPI’s basket represents the entire economy. Measures same goods every year. Tracks changes from year to year. PPI – Producer Price Index Measures goods & services bought.

The Market basket

The Market Basket What goes into the CPI? Housing39.6% Transportation17.6% Food16.3% Entertainment6.1% Medical Care5.6% Education and Communication 5.5% Apparel and Upkeep4.9% Other4.3%

Calculating CPI Step One: Set Market Basket Step Two: Calculate CPI P 1 *Q 1 +P 2 *Q 2 +…+P N *Q N =CPI Step Three: Convert to base year CPI CY /CPI BY *100

Calculating Inflation Rate Equals rate of change of CPI’s I = (CPI Y2 – CPI Y1 )/CPI Y1 *100 Example: Year A CPI = 140 Year B CPI = 145 I = ( )/140*100 = 3.57%

Yearly CPI numbers

Inflation & the dollar

Interpreting Inflation rates Moderate 1 to 3 percent. Historically 3.41 % (since 1913) Double digit inflation Considered high in developed countries Hyper inflation Runaway inflation, can reach rates in excess of 100%.

5 Major Effects of Inflation Decreased purchasing power Decreased value of real wages Increased interest rates Decreased savings & investing Increased production costs

Decreased Purchasing Power Purchase less for same amount. Affects People on Fixed-Incomes. Pensions, disabilities. COLA’s Cost of living adjustments.

Decreased Value of Real Wages Nominal vs. Real wages Typically, wages increase more than inflation Huge issue if real wages decrease

Increased Interest Rates Interest rates reflect Expectations on future value of the dollar Demand for money Profits Effects of high interest rates Decrease in consumer spending Credit card costs increase

Decreased Savings & Investments Savings Real value of money less Value of savings therefore less Investing Need for higher returns to compensate for inflation. Cheaper to purchase now b/c of stronger dollar – decreases amount for investing.

Increased Production Costs Most businesses operate with short- term or market pricing on costs. Inflation hits production costs quickly. Long-term debt at lower rates one as benefit of inflation for companies.