1. Inflation

2. Today’s Objective After today’s lesson, students will be able to…
Explain inflation and its causes
Calculate both CPI and the inflation rate
Essential Skill:
Gather and organize information

3. Do Now Answer Questions 1, 2, and 3 on the packet.
Do not continue past first three questions
Be prepared to share your answers.

4. Measuring Inflation
A market basket is a bundle of goods and services that an average consumer might buy

5. Measuring Inflation
The Consumer Price Index (CPI) is a measure of the overall price level faced by a typical consumer

6. Candy Auction Two rounds Highest bidder gets the good
Must be able to pay for the good

7. Candy Auction
Market Basket When economists want to see how prices have changed over time, they use a system of calculation that utilizes a hypothetical market basket. A market basket is a set of consumer goods and services that is used to compare changing price levels over time. What six items were in our classroom’s market basket?

8. Calculate the CPI
Now that we know the cost of the market basket in the first round and the cost of the market basket in the second round we can calculate CPI.
CPI = Cost of the market basket in round 2
Cost of the market basket in round 1
X 100
(Base year)

9. Calculating Inflation Rates
New CPI-Old CPI Old CPI
Inflation Rate =
x100

10. Defining Inflation Inflation is a rise in the price level
The inflation rate is the annual percentage increase in the price level
Deflation is a decline in the price level

11. Costs of Inflation True Costs of High Inflation
Shoe leather costs are the costs of time and effort involved in frequent trips to the bank or ATM to avoid holding much cash during periods of high inflation

12. Costs of Inflation True Costs of High Inflation
Hyperinflation is very rapid inflation
Hyperinflation usually leaves a country’s currency worthless
Bread in Germany
Nov 1918 = 1 mark
Nov 1922 = 163 marks
Sep 1923 = 1,500,000 marks
Nov 1923 = 200,000,000,000 marks

13. Costs of Inflation True Costs of High Inflation
Menu Costs are the costs of updating prices due to inflation
Price changes not just in restaurants but in grocery stores and sales contracts – across the economy changes

14. Costs of Inflation True Cost of High Inflation Unexpected Inflation
In general, people who borrow money benefit when inflation turns out to be higher than expected. But people who lend money lose from higher than expected inflation
Unexpected inflation makes borrowing and lending more risky. Lenders may be hesitant to lend and borrower may not wish to borrow

15. Causes of Inflation
It is generally considered that these four events cause inflation
1. Money Supply Increase
Prices will increase if “too many dollars are chasing too few goods”
2. Money Demand Decrease
This has the same effect as having more money in the economy
3. Aggregate Demand Increases
When people want to buy more goods, prices will rise, which is called demand-pull inflation
4. Aggregate Supply Decreases
If production costs increase in an economy, the supply decreases which is cost-push inflation

16. The Inflation Myth
Inflation reduces the number of goods and services we can buy with each dollar that we earn
Price Stability exists when inflation is low – 2 or 3 % per year (optimal rate)

17. Deflation and its Effects
Deflation – a decrease in the price level
Causes consumers to reduce spending
Postpone major purchases
Decrease in Aggregate Demand, contraction in economic activity
Dollar incomes also fall
More difficult to pay debts that do not change
Banks’ losses mount as more bankruptcies occur
Economic activity becomes risky and spending decreases