1. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-1 Chapter 19 Inflation Source: Adapted from Reserve Bank, Bulletin, February 2004, Graph 70. Data supplied by Australian Bureau of Statistics and Reserve Bank of Australia.

2. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-2 Lecture Plan Measuring inflation Causes of inflation Demand-pull and cost-push inflation The inflationary gap Redistributive effects of inflation Australian inflation trends since the 1990s International comparisons

3. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-3 Inflation A rising general level of prices Australia’s inflation rate is announced quarterly. To get an annual inflation rate: – Multiply the last quarter rate by 4, or – Add the previous three quarterly inflation rates Rising prices see the value of money decreasing

4. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-4 Consumer Price Index, Australia, 1991 to 2003, % Change p.a.

5. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-5 Causes of Inflation: Demand-pull Inflation Demand for goods and services > Supply for same That is where supply cannot increase because the economy is operating at full capacity—all resources are being used The excess demand will bid up the prices of the fixed real output

6. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-6 Demand-pull Inflation Ep Ep 1 D D1D1 S Eq Eq 1

7. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-7 The Inflationary Gap The excess demand that cannot be satisfied when the economy is operating at full capacity How the government can close the gap: Reduce G 1 and G 2 Increase personal income tax Increase interest rates Reduce tariffs on imported goods

8. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-8 Factors Causing Increased Expenditure (Demand) Increased government expenditure (e.g. welfare, health, defence, infrastructure) Increased consumer spending, depending on – level of disposable income – level of sales taxes – the cost and availability of credit Increased private investment expenditure Increased overseas demand

9. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-9 Cost-push Inflation Ep Ep 1 E E1E1 S S1S1 D

10. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-10 Cost-price Spiral Increased costs of production Rising product prices Demand for higher wages

11. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-11 Price Indices The Consumer Price Index (CPI) – Quarterly changes in the price of a ‘basket’ of goods and services (eight broad headings) – Group weightings – Only metropolitan households, wage and salary earners GDP deflator (IPDI)= – Nominal GDP/Real GDP × 100 Measuring Inflation

12. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-12 Australia’s CPI and Real GDP, % Change p.a., 1990 to 2003 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 19901991 199219931994199519961997199819992000 200120022003 % p.a. Real GDP CPI Source: Adapted from OECD, Economic Outlook, July 2004.

13. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-13 Change in Consumer Prices, Various Countries, 1990 to 2003, % p.a.

14. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-14 Redistributive Effects of Inflation Real income measures the amount of goods and services your money income can buy, e.g. % change in real income = % change in nominal income – % change in price level Adverse redistributive effects of inflation on: – Fixed-nominal-income receivers (e.g. fixed pension) – Savers (when rate of inflation > interest rates) – Creditors (redistribution benefiting debtors)

15. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-15 Interest Rate Indicator (90-day Bank Bills) and the CPI, 1990 to 2003

16. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 19-16 Australian Inflation Trends in the 1990s and 2000s Australia has become a low-inflation country Main cause: the government seeking higher revenue through indirect taxes and charges due to – Adoption of a user-pays philosophy – Slow rate of growth of wages Housing costs went down as a result of lower interest rates Australia has continued to have relatively low inflation rates into the 2000s, compared to rates in the 1970s and 1980s