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Inflation and Deflation

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wasif muhammad

on 13 January 2014

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Transcript of Inflation and Deflation

What is inflation?
Inflation is a general increase in the price level of goods and services produced by the economy.
CPI= Consumer Price Index
The role of CPI in Inflation
Deflationary periods can be both short or long, relatively speaking
The decline in prices of assets, is often known as Asset Deflation
Deflation is generally regarded negatively, as it causes a transfer of wealth from borrowers and holders of illiquid assets, to the benefit of savers and of holders of liquid assets and currency, and because confused pricing signals cause mal-investment, in the form of under-investment.
Inflation Can Be Harmful...
If Your wages/salaries remain the same when an inflation occurs, you will lose purchasing power.
you are now only able to buy fewer goods and services than before with your pay cheque.
What is CPI?
A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.

Inflation and Deflation
Inflation
Deflation
On the other hand...
A general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending.
If your wage/salary increases at the same rate of the inflation it will be neutral and there will be no harm.


If I went to the grocery shop, I could buy 5 bananas for $1.00 but one year from now those 5 bananas would probably cost me $1.05. Therefore a 5% inflation has occurred.
For Example:
Why does inflation occur?
Inflation mainly occurs because a country is printing more money. It also occurs because of :

Demand Pull Factor
- Takes place when demand is increasing more than supply which results in prices to increase. "too much money chasing too few goods"
Cost Push Inflation-
When the costs to run a business increases such as increased wages or taxes, they increase prices to maintain profit margins.

The central banks of countries
generally set a 2-3% increased
inflation rate per year.
But overall inflation can be a good
thing because it means that the
economy is growing.
Pros and Cons of Deflation
What is Deflation?
Rewards saving—
Deflation rewards the patient and prudent by increasing the value of their savings. Even savers who receive almost no interest are rewarded for their thrift, as the value of simple savings increases. Prices drop, and people can buy more.
Pensions increase—
Deflation rewards people on pensions and those who receive annuities by making their regular payments worth more. The dollar amount of their payments does not go up, but pensioners can buy more with their money. They no longer worry about outliving it.
Bails out government—
In a sense, the government receives a pension because it has a reliable stream of income from taxes. In a deflation, the money the government receives from its citizens increases in value. At the same time, the government can afford to pay less when it borrows because, in deflationary circumstances, savers and investors flock to the safety of government bonds. Nevertheless, the government has substantial problems
Pro's:
Con's:
Increases burden of government debt—
The burden of government debt increases in deflation, just as the burden of all debt increases. The government must pay back the money it borrowed with money that is worth more than the dollars it borrowed. In a deflation, government revenues are likely to decrease, as well as possibly increasing the need to borrow.
Makes debt a bigger burden for consumers—
When the value of money is increasing due to deflation, all debtors are forced to repay their debts with money that will buy more than the dollars they borrowed did. As deflation increases, a borrower’s real debt increases, until he or she may feel the wisest course is to stop repaying it.
Discourages spending—
Deflation discourages spending because consumers believe that if they hold on to their money, it will grow in value. At the same time, borrowers are being discouraged from borrowing, and the combination will stifle growth in the economy. People become unwilling to buy homes or to start new enterprises that require capital; they simply hold on to their cash.
Encourages unemployment—
Deflation tends to decrease the price of goods and services, as money becomes more valuable. Therefore, enterprises get less money for the goods and services they sell and need to lower wages. However, employees naturally resist wage cuts because they have fixed costs, like mortgages and car payments. Therefore, in order for wages to fall along with deflation, unemployment must rise so that workers will accept lower pay.
Government uses CPI as one of the factors to determine the rate of inflation, changes in CPI and changes in inflation rates are usually correlated.

Calculations for CPI change (%):
Present price/past price*100 -100


$
1
$
2
Change in CPI for apple: 2/1*100-100=+100%
Households want CPI change to be low, because people don't want pay a higher price for the same product each year.
Labour Market and Inflation
Differences and similarities between Inflation and CPI
CPI and inflation are all determinants for the cost of living.

CPI measures the costs to buy basic goods, the CPI change can be different in different sectors. Examining CPI in different sectors can give the economists a general view of the economy and how well is each sector doing.
-Inflation measures the buying power of money.
-CPI measures the prices of goods sold.

CPI can be seen as another way to express inflation, through a different perspective.


Wages paid are always increasing, due to the "sticky wages property". The working force might be happy to get a wage increase, but did your buying power ACTUALLY increase?
Full transcript