What do economists Look at when evaluating price changes over time? Inflation What do economists Look at when evaluating price changes over time?

Inflation Examining Price Fluctuations Aggregate Supply Price Level Aggregate Supply Total amount of goods and services produced throughout the economy Aggregated Demand Total amount of spending by individuals and businesses throughout the economy

Inflation Inflation Deflation Average price level increases for all products in the economy AG Demand increases faster than AG Supply Price increases cause value of a dollar to decrease Deflation Decrease in price level of all products in an economy AG Demand decreases faster that AG Supply Price decreases causes value of a dollar to increase

Inflation Purchasing Power The amount of real goods and services that a dollar can buy is called purchasing power. Purchasing power does not vary directly with inflation Nominal value of dollar is the actual value. The real value is what it can buy. If I give you a dollar today and you save it until next year its real value will be less than its nominal value

Inflation Anticipated Inflation Unanticipated Inflation inflation rate that we believe will occur Unanticipated Inflation inflation rate that comes at a surprise Unanticipated Inflation hurts those that lend money (fixed rate loan is getting paid back with inflated money that buys less. Lenders lend money to make money. They must take inflation into account. If unanticipated inflation occurs they are hurt because the interest rate they charged was not large enough.

Who is Hurt by Inflation? Fixed- Income People Savers Creditors Who is unaffected or Helped by Inflation? Flexible-Income Receivers Debtors

Rate of Interest Nominal rate of interest rate expressed in today's dollars Nominal Interest Rate = Real Interest + Inflation Premium (expected rate of inflation) Real rate of interest nominal rate of interest minus the anticipated rate of inflation Inflation causes interest rates to rise COLA Cost of living adjustment: an automatic increase in income when inflation rate increases

Inflation Causes of Inflation Demand-Pull Inflation AG Demand increases faster than the economy’s productivity causing the price level to increase but real GDP stays the same Pulls prices even higher Increase in Money supply and credit Cost-Push Inflation Producers raise prices to cover the higher resource costs causing a rise in price and Real GDP falls Price Expectation Supply Shock- increase the cost of production for all or many firms

Demand-pull inflation Cost-Push Inflation Demand-pull inflation

Inflation

Inflation Measuring Inflation Consumer Price Index (CPI) Measure of the average change over time in the price of a fixed group of products 1st Select a base year to measure price change Market Basket- bureau selects a sample of commonly purchased consumer items Producer Price Index Average change over time in the price of goods and services bought by producers Based on some 3200 products Inflation Rate Monthly or annual percentage change in price IR= [(CPI year B- CPI year A) / CPI Year A] X 100

Inflation Hyperinflation- worst degree of inflation EXAMPLE- Germany after WWI

Effects of Inflation Inflation Decrease purchasing Power of a Dollar Decrease Value of Real Wages Increased Interest Rates Decreased Saving and Investing Increased Production Costs