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# Chapter 18-inflation

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### Chapter 18-inflation

1. 1. Written by: Edmund Quek CHAPTER 18 INFLATION LECTURE OUTLINE 1 DEFINITION AND MEASUREMENT 2 CAUSES OF INFLATION 2.1 2.1.1 2.1.2 2.2 Keynesian view Demand-pull Inflation Cost-push Inflation Monetarist view 3 EFFECTS OF INFLATION 4 EFFECTS OF DEFLATION References John Sloman, Economics William A. McEachern, Economics Richard G. Lipsey and K. Alec Chrystal, Positive Economics G. F. Stanlake and Susan Grant, Introductory Economics Michael Parkin, Economics David Begg, Stanley Fischer and Rudiger Dornbusch, Economics © 2011 Economics Cafe All rights reserved. Page 1
2. 2. Written by: Edmund Quek 1 DEFINITION AND MEASUREMENT Inflation is a rise in the general price level over a period of time. Monetary economists, however, define inflation as a sustained rise in the general price level and refer to a one-off rise as a price shock. The inflation rate is calculated as the percentage increase in the Consumer Price Index over a period of time. Mathematically, t  (CPIt  CPIt1)/CPIt1 × 100, where CPIt  [(Pit/Pi base year × 100) × Wi]. The Consumer Price Index is a price index which measures the cost of a basket of goods and services purchased by the average household. It is calculated by choosing a basket of goods and services purchased by the average household, grouping them into categories, assigning a weight to each category based by the proportion of total expenditure spent on it, choosing a base year, measuring the prices of the goods and services in the current year as well as in the base year. Suppose that there are only two goods produced in the economy, Good A and Good B. Further suppose that the base year is 2009 (i.e. CPI2009  100). Good A B Price (2009) \$8 \$16 Price (2011) \$10 \$15 Price (2012) \$12 \$14 Expenditure (2009) 20000 60000 Weight 1/4 3/4 CPI2012  [(12/8 × 100) × 1/4]  [(14/16 × 100) × 3/4]  103.125 CPI2011  [(10/8 × 100) × 1/4]  [(15/16 × 100) × 3/4]  101.563 2012  (CPI2012 – CPI2011)/CPI2011 × 100  (103.125 – 101.563)/101.563 × 100  1.538 In most economies, a low/moderate/mild inflation rate is considered to be 3 per cent or lower. Most economies that have inflation targets have set them in this range. Inflation much higher than this range is called high inflation. Hyperinflation is very high inflation. An example of hyperinflation is the 6.5 × 10108 per cent inflation rate in Zimbabwe in 2008. Note: Many lecturers use the monetary economists’ definition of inflation. However, some of them use it without knowing that not all economists define inflation in the same way. A check with economics textbooks (e.g. Lipsey, Mankiw, etc) will confirm this. © 2011 Economics Cafe All rights reserved. Page 2