1. Causes of Inflation

2. What is inflation? A sustained rise in the level of prices OR a fall in the purchasing power of money How do you measure inflation? – Use the CPI (consumer price index) A measure of changes in the prices of goods and services purchased by consumers US gov’t surveys people across the country to see what people buy regularly

3. Produce Price Index (PPI) Shows the level of inflation experienced by producers Constructed similarly to the CPI but takes into account the prices the producers get for the goods rather than the prices consumers pay PPI leads CPI as an indicator of inflation Use both CPI and PPI to calculate the inflation rate = the rate of change in prices over a set period of time

4. The Rate of Inflation Year AYear BYear C 1 gallon of milk$2.50$2.40$2.60 1 loaf of bread$1.00$1.35$1.53 1 gallon of juice$2.00$2.30$2.20 Price of market basket $5.50$6.05$6.33 CPI, base: Year A100110115 To calculate the rate of inflation, economists use a market basket of hundreds of goods. The market basket is intended to represent the goods that are purchased by a typical urban consumer.

5. Types of inflation Hyperinflation = a rapid, uncontrolled of inflation in excess of 50% per month – Ex: Hyperinflation in Germany in the 1922 and 1923 when prices rose at about 322% per month Deflation, a decrease in general price level – Happens more rarely – Ex: Great Depression in 1930s marked by deflation

6. What causes inflation? The Quantity theory = too much money in the economy When demand increases: – Demand-pull inflation occurs = when total demand rises faster than the production of goods and services – Creates scarcity that drives up prices

8. What causes inflation? When supply increases: – Cost-push inflation occurs = prices are pushed up by rising production costs – When production costs increase, producers make less of a profit – Ex: OPEC in 1973 and 1974 limited the amount of oil sold to the US  rapid rise in the price of oil led to cost-push inflation Wages are also part of the production costs – Wage-price spiral = a cycle that begins with increase wages, which leads to higher production costs, which results in higher prices, which results in demands for even higher wages

10. Impact of Inflation Effect #1: Decreasing value of the dollar – Today’s dollar buys less than last year’s dollar – Those vulnerable: senior citizens (live on a fixed retirement income); college students Effect #2: Increasing Interest Rates – As prices increase, so do interest rates – Happens to ensure lenders earn money on their loans despite inflation – Means that borrowing money becomes more expensive Effect #3: Decreasing Returns on Savings – People who save at a fixed interest rate get a lower rate of return