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Transcript of Inflation
So what is inflation?
Inflation is the rate in which general goods and services increase in price, while purchasing power decreases.
As inflation rises every dollar will buy a smaller percentage of a good/service. So if inflation is at 3% a dollar candy bar will now cost $1.03
Annual inflation rate is determined by looking at the percentage change in the General Price Index (Consumer Price Index) over time. CPI measures the cost of a "market basket" of consumer goods and services over time.The CPI has risen steadily since 1940.
Factors of Inflation
Increase in the money supply.
Decrease in the demand for money.
Decrease in the aggregate supply of goods and services.
Increase in the aggregate demand for goods and services.
So how does Demand-Pull Inflation work?
This type of inflation is the result from rapid increases in demand. The aggregate demand out paces the aggregate supply in the economy. Many economists refer to this as "too many dollars chasing too few goods". When this happens the general price level will increase causing the devaluation of the dollar.
So how can inflation be fixed?
With some help from these guys
The Federal Reserve can do several things to combat Inflation
Can adjust the amount of money each bank is required for their reserves on hand.
Raise interest rate to make money "more rare"
Open Market Operations where the Federal Reserve sells treasury bills or bonds.
Some fun fact$:
The current annual inflation rate for July 2012 was 1.41% .
A dollar from 1950 is now worth only $0.12.
Most rapid monthly inflation increase ever: 41,900,000,000,000,000 % (41 quadrillion %) in Hungary for July 1946, which means prices doubled every 13.5 hours.
- a type of inflation caused by substantial increases in the cost of important goods or services where no suitable alternative is available.
example: when oil became scarce in the 1970s, the prices of many important goods increased, raising the inflation rate
Expected and Unexpected Inflation
What is the difference between expected and unexpected inflation?
is the predicted inflation rate for the next year
is when the actual rate turns out to be different from the predicted rate
Unexpected inflation causes more problems than expected inflation
What kind of effect does inflation have on the economy's performance?
Unexpected inflation creates winners and losers for employees in the economy
This is because both employees and employers plan on a certain inflation, and will lose money if the rate is not the expected one
For example, if inflation for the next year is expected to be 3 %, and you will have a 4 % wage increase that is agreed on with your company, both are expecting that your
will increase by 1%
If inflation for the next year turns out to be 4 %, you as the employee actually have a 0 % increase in your
So the company wins, and you lose
If inflation for the next year turns out to be 2 %, you earn a 2 % increase in your
So in this case, you win, but your company loses
Unexpected inflation arbitrarily redistributes income and wealth from one group to another
If inflation is uncertain, companies have a harder time planning, so economic growth slows
Effect of Inflation on Interest Rates
What is interest?
Interest is the cost of borrowing and the reward for saving
There are two ways of measuring interest rates
nominal interest rate
- measures interest in current dollars
real interest rate
- measures interest in dollars of constant purchasing power as a percentage of the amount loaned
Or, Real interest =
nominal interest rate - inflation rate
Cost Push Inflation Graph
Example: During the holidays new toys come on sale, many become the "hottest" product to buy for some consumers. The demand that the product makes and the limited supply of the toy, vendors may raise prices.