3. 2.) CPI ā measuring Inflation
Inflation:
4.) Causes of Inflation
1.) Inflation Vocabulary
5.) Consequences of Inflation
3.) Problems of CPI
Part 1
Part 2
Part 3
7. - Your money buys less stuff!Falling purchasing power
Problems:
5.) Consequences of Inflation
- Holding money as cash doesnāt have
an interest rate. More trips to the
bank may be necessary.
Shoe leather costs
Menu costs - Difficult for firms to change prices
often.
Taxes distortedęę² - Taxes usually donāt count inflation,
and can cause a larger burden č“ę .
Inflation redistributes income - Can be unexpected and undesired!
8. Problems:
5.) Consequences of Inflation
- Holding money as cash doesnāt have
an interest rate. More trips to the
bank may be necessary.
Shoe leather costs
The idea comes from the old days
of having to walk back and forth
to the bank a lot, it wore holes in
your shoes.
(a type of opportunity cost)
9. Problems:
5.) Consequences of Inflation
Menu costs - Difficult for firms to change prices
often.
Some firms can change prices
quickly. (low opportunity
costs to do so.)
Some firms is very costly to
change their prices often.
(high opportunity costs to do
so.)
10. Problems:
5.) Consequences of Inflation
Inflation redistributes income - Can be unexpected and undesired!
Not always desirable,
sometimes redistributes
taking income from poor
people and giving more
income to rich people.
11. Overall Inflation redistributes income arbitrarily and can be
unexpected or not desired.
5.) Consequences of Inflation
- Some people win ā the ones
getting the higher prices
(think oil/gas companies)
- Some people lose ā the ones
paying the higher prices
(think YOU!)
12. 5.) Consequences of Inflation
Inflation Winners:
Debtors
Many firms
Inflation Losers:
Government
(sometimes)
Lenders
Some payers
Most savers
Inflation and uncertainty
ļ Do I spend today, or
save? Prices going
up or not? What is
happening to my
purchasing power?
ARRRGGHH!
13. 5.) Consequences of Inflation
Inflation Winners:
- The ones getting the higher prices.
example:
- oil/gas companies
Debtors - Pay back with less valuable money
example:
- borrow money from the bank
Many firms
Inflation Losers
Government
(sometimes)
- Biggest debtor in the world (Debtors WIN!)
- Can get high taxes revenue
14. 5.) Consequences of Inflation
Inflation Winners:Inflation Losers:
- The ones paying the higher prices. Falling real
incomes.
example:
- you and me
- fixed incomes
Lenders - Get paid back with inflated dollars.
(dollars that are worth less)
example:
- banks, creditors
Some payers
Most savers - Saving is losing value over time.
17. - a sustained increase in the cost of living or
the general price level leading to a fall in
the purchasing power of money.
Inflation
- is measured by the annual percentage
change in consumer prices.
Rate of
Inflation
1.) Inflation Vocabulary
- when the rate of inflation becomes
negative.
Deflation
- the value of money becomes worthless.Hyperinflation
- ā¦ā¦ā¦ā¦ā¦ā¦ā¦ā¦ā¦ā¦.hless.Stagflation
18. - measures the typical consumerās cost of
living with only the typical things that are
purchased.
- the main way to measure inflation.
Consumer Price
Index (CPI)
1.) Inflation Vocabulary
19. How the CPI Is Calculated:
- Government surveys consumers to
determine whatās in the typical consumerās
āshopping basket.ā
2.) CPI ā measuring Inflation
1.) Fix the ābasketā
- Government then collects data on the
prices of all the goods in the basket.
2.) Find the prices
3.) Compute the
basketās cost
-Use the prices to
compute the total cost of
the basket.
20. How the CPI Is Calculated:
- The CPI in any year equals:
2.) CPI ā measuring Inflation
4.) Choose a base year and compute the index
100 x
cost of basket in current year
cost of basket in base year
- The percentage change in the CPI from the preceding period:
5.) Compute the inflation rate
CPI this year ā CPI last year
CPI last year
Inflation
rate
x 100%=
21. 3.) Problems of CPI
*** The general problem is that CPI
tends to overstate the actual increase
in the cost of living.
- Introduction of New Goods
- Substitution Bias
- Unmeasured Quality Change
- Discount sales
22. Different parts of this theory that brings us to the conclusions we will work with:
Classical Dichotomy
Quantity Theory of Money
Neutrality of Money
Velocity of Money (V of Money) - the rate at which money
changes hands.
v =
P x Y
M
Equation:
Inflation and the Classical Theory
23. Long Run Aggregate
Supply (LRAS)
Price
level
GDP
LRAS
Y
P1
P2Therefore: With the quantity
equation (fisher equation) if V
is stable that means an increase
in M just means and increase
in P and not Y, so in the long
run we just have inflation only.
M x V = P x Y
Inflation and the Classical Theory
24. MS1
$1000
Value of
Money, 1/P
Price
Level, P
Quantity
of Money
1
Ā¾
Ā½
Ā¼
1
1.33
2
4
MD1
EQ
price
level
EQ
value
of
money
A
MS2
$2000
B
Then the value of
money falls,
and P rises.
Suppose the central
bank increases the
money supply.
2.) Money supply ā demand diagram
25. How does this work? Short version:
ļ At the initial P, an increase in MS causes
excess supply of money.
ļ People get rid of their excess money by
spending it on g&s or by loaning it to others,
who spend it. Result: increased demand for
goods.
ļ But supply of goods does not increase,
so prices must rise.
Result from graph: Increasing MS causes P to rise.
2.) Money supply ā demand diagram
Quantity Theory of Money
Price
level
GDP
LRAS
Y
P1
P2
27. 4.) Causes of Inflation
2.) Cost-Push
Reasons:
a.) Input costs rise - Raw material costs rise.
b.) Labor costs rise - Pay more for workers means
increased input costs.
c.) Fall in the
exchange rate - Raw materials imported
costs rise.
d.) Expectations of
inflation
- If inflation is expected, raise
prices even higher.
29. 4.) Causes of Inflation
3.) Demand-Pull
Reasons:
a.) Growing economy - Demand rising faster then supply
can keep up.i.) *wealth effect
b.) Fall in the
exchange rate
- Demand internationally rising
faster then supply can keep up.
c.) Expectations of
inflation
- If inflation is expected, raise
prices even higher.
30. - Your money buys less stuff!Falling purchasing power
Problems:
5.) Consequences of Inflation
- Holding money as cash doesnāt have
an interest rate. More trips to the
bank may be necessary.
Shoe leather costs
Menu costs - Difficult for firms to change prices
often.
Taxes distortedęę² - Taxes usually donāt count inflation,
and can cause a larger burden č“ę .
Inflation redistributes income - Can be unexpected and undesired!
31. 5.) Consequences of Inflation
Inflation Winners:
Debtors
Many firms
Inflation Losers:
Government
(sometimes)
Lenders
Some payers
Most savers
Inflation and uncertainty
ļ Do I spend today, or
save? Prices going
up or not? What is
happening to my
purchasing power?
ARRRGGHH!