1. CONTEMPORARY ECONOMICS© Thomson South-Western 13.2Inflation  Describe the types of inflation, and identify two sources of inflation.  Identify the problems that unexpected inflation creates. Objectives

2. CONTEMPORARY ECONOMICS© Thomson South-Western 13.2Inflation  inflation  demand-pull inflation  cost-push inflation  nominal interest rate  real interest rate Key Terms

3. CONTEMPORARY ECONOMICS© Thomson South-Western 13.2 Inflation SLIDE 3 Inflation Basics Inflation is an increase in the economy’s general price level.

4. CONTEMPORARY ECONOMICS© Thomson South-Western 13.2 Inflation SLIDE 4 Types of Inflation Hyperinflation—extremely high inflation Disinflation—a reduction in the rate of inflation Deflation—a decrease in the general price level

5. CONTEMPORARY ECONOMICS© Thomson South-Western 13.2 Inflation SLIDE 5 Two Sources of Inflation Demand-pull inflation is inflation resulting from increases in aggregate demand. Cost-push inflation is inflation stemming from decreases in aggregate supply.

6. CONTEMPORARY ECONOMICS© Thomson South-Western 13.2 Inflation SLIDE 6 Inflation Caused by Shifts of the Aggregate Demand and Aggregate Supply Curves (a)Demand-pull inflation: inflation caused by an increase of aggregate demand (b)Cost-push inflation: inflation caused by a decrease of aggregate supply Figure 13.4

7. CONTEMPORARY ECONOMICS© Thomson South-Western 13.2 Inflation SLIDE 7 Consumer Price Index Since 1913 Despite fluctuations, the price level, as measured by the consumer price index, was lower in 1940 than in 1920. Since 1940, the price level has risen almost every year. Figure 13.5

8. CONTEMPORARY ECONOMICS© Thomson South-Western 13.2 Inflation SLIDE 8 Impact of Inflation Inflation reduces the value of the dollar and takes away confidence in the value of the dollar over the long term.

9. CONTEMPORARY ECONOMICS© Thomson South-Western 13.2 Inflation SLIDE 9 Expected Versus Unexpected Inflation Unexpected inflation creates more problems for the economy than does expected inflation. To the extent that inflation is higher or lower than expected, it arbitrarily creates economic winners and losers.

10. CONTEMPORARY ECONOMICS© Thomson South-Western 13.2 Inflation SLIDE 10 The Transaction Costs of Unexpected Inflation Reduced productivity Increased transaction costs of market exchange

11. CONTEMPORARY ECONOMICS© Thomson South-Western 13.2 Inflation SLIDE 11 Inflation and Interest Rates Nominal interest rate—the interest rate expressed in current dollars as a percentage of the amount loaned; the interest rate on the loan agreement. Real interest rate—the interest rate expressed in dollars of constant purchasing power as a percentage of the amount loaned; the nominal interest rate minus the inflation rate. Real interest rate = Nominal interest rate – Inflation rate