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INFLATION

is the rate of upward movement in the general price

level for an aggregate of goods and services
is a rise in the general (or average) level of prices of
goods and services in an economy over a period of time.

is the overall increase in price level

Example of Inflation
Goods

Price in
1970

Price in
2008

Differen
ce

Percent
Change
in Price

New York
Times
newspaper

$.15

$1.50

$1.35

900%

Single-family
home

$23,400

$183,300

$159,900

683%

Average
wage in
Manufacturin
g

$3.36/hr

$19.85/hr

$16.39/hr

488%

Consumer Price Index

The index that is used to measure average changes in
prices paid by consumers in urban markets for a market
basket of commonly purchased goods and services.
Compares the combined price of all of these goods and
services in the market basket from one month to the next.
The Bureau of Labor Statistics collects information about
the prices of goods and services in eight major categories.

The Eight Major Categories

FOOD AND BEVERAGES
(breakfast cereal, milk, coffee, chicken, full service meals, snacks)

HOUSING
(rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture)

APPAREL
(men's shirts and sweaters, women's dresses, jewelry)

TRANSPORTATION
(new vehicles, airline fares, gasoline, motor vehicle insurance)

MEDICAL CARE
(prescription drugs and medical supplies, physicians' services, eyeglasses and eye care,
hospital services)

RECREATION
(televisions, toys, pets and pet products, sports equipment, admissions)

EDUCATION AND COMMUNICATION

(college tuition, postage, telephone services, computer software and accessories)

OTHER GOODS AND SERVICES

(tobacco and smoking products, haircuts and other personal services, funeral expenses)

Working with CPI

Changes in the index can be expressed as percent changes,
either monthly or annually, called the inflation rate.

The inflation rate: the percent change in the CPI

over the reference period.

CPI (Present) - CPI (Past)

CPI (Past)

Example

CPI

CPI

(Year 1) (Year 2)

Calculations

Inflation
Rate

1995

148.2

152.4

[(152.4 148.2)/148.2] x 100

2.8%

2005

188.9

195.3

[(195.3 188.9)/188.9] x 100

3.4%

2012

224.9

229.6

[(229.6 224.9)/224.9] x 100

2.1%

Causes of Inflation
Increase in money supply
Decrease in the demand for money

Increase in the aggregate demand of goods and services

Decrease in the aggregate supply of goods and services

Types of Inflation

Demand-Pull Inflation

occurs when total spending exceeds the

economy's ability to provide goods and services
at the existing price level; total spending "pulls" the
prices level upward commonly desribed as "too
much money chasing too few goods."

Cost-Push Inflation
occurs when factors such as excessive wage increases
and rapid increase in raw material prices drive up per
unit production costs and these higher costs "push"
the price level upward.

Demand-Pull Inflation

Demand-Pull Inflation

Cost-Push Inflation

Cost-Push Inflation

ANTICIPATED AND UNANTICIPATED INFLATION

Anticipated Inflation
expected, known, predicted

Unanticipated Inflation
unexpected, unknown, unpredicted

EFFECTS OF INFLATION
1. Effects on Redistribution of Income and Wealth:
(1) Debtors and Creditors
(2) Salaried Persons
(3) Wage Earners
(4) Fixed Income Group
(5) Equity Holders or Investors
(6) Businessmen
(7) Agriculturists
(8) Government

2. Effects on Production
(1) Misallocation of Resources
(2) Changes in the System of Transactions:
(3) Reduction in Production
(4) Fall in Quality
(5) Hoarding and Black marketing
(6) Reduction in Saving
(7) Hinders Foreign Capital
(8) Encourages Speculation

EFFECTS OF INFLATION

Other Effects
(1)
(2)
(3)
(4)
(5)
(6)

Government
Balance of payments
Exchange Rate
Collapse of the Monetary System
Social
Political

The inconvenience of reducing money

holding is metaphorically called the
shoe-leather cost of inflation, because
walking to the bank more often induces
ones shoes to wear out more quickly.
When changes in inflation require printing
and distributing new pricing information,
then, these costs are called menu costs.

Another cost is related to tax laws. Often

tax
laws do not take into consideration
inflationary effects on income.

Unanticipated inflation is unfavorable because it

arbitrarily redistributes wealth among individuals.
For example, it hurts individuals on fixed pensions. Often
these contracts were not created in real terms by being
indexed to a particular measure of the price level.

There is a benefit of inflationmany economists say that

some inflation may make labor markets work better.
They say it greases the wheels of labor markets.

WINNERS AND LOSERS IN

INFLATION
Lenders
Goal: Loan funds at a rate of interest that is higher than inflation. If the interest
rate charged is more than the actual inflation rate, the purchasing power of
the money paid back to the lender is greater. If not, the purchasing power
of the money paid back to the lender decreases.
Borrowers
Goal: Borrow funds at the lowest possible interest rate. If the inflation rate is
higher than the interest rate on the loan, the purchasing power of the funds
that the
borrower pays back decreases, so a borrower may find it easier to pay back the
loan (particularly if wages have increased with inflation).
Savers
Goal: Save funds at a rate of interest higher than inflation. If the interest rate
earned is higher than the actual inflation rate, the purchasing power of savings
increases. If not, the purchasing power of the savings decreases.
Workers
Goal: Earn wages that increase at a rate that is higher than the inflation rate. If
wages increase faster than the rate of inflation, the purchasing power of the
wages increases. If not, the purchasing power of the wages decreases.

 An extreme level of inflation is called

hyperinflation. During hyperinflation
the inflation rate is above 200 percent
for at least a year or more.
Hyperinflation recently occurred in
Russia during the early 1990s. The
currency essentially becomes worthless
and spending declines.

The second consequence of inflation is

speculation. Under speculation
people and companies will alter buying
and spending activity if higher rates of
inflation are anticipated.

 Under speculation people will buy necessary goods

now to avoid price increases. Businesses will increase
production now and increase inventories to be sold later
at a higher profit.

Another result of inflation is bracket creep. This is the

movement of taxpayers into higher tax brackets (rates)
as nominal incomes grow. If incomes rise under
inflation, more taxpayers enter higher federal tax
brackets and pay more taxes resulting in an increase in
federal tax collections.

DEFLATION
Words of Prof. Crowther;
Deflation is that state of the economy where the value of money
is
rising or prices are falling.

If the general level of prices falls and as a result

thereof,
the value of money increases, it is called deflation in
economics.
Deflation is just the opposite of inflation.

CAUSES OF DEFLATION
Deflationary situation may occur due to the following
terms;
Private investment
Persistent unfavorable balance of payments
Continued Govt.-budgetary surpluses
Increase in the total output
To rise the discount rate by the Central Bank
By selling securities

MEASURE TO CONTROL
DEFLATION
Prof. J. M. Keynes strongly views that prices can be
stabilized more by fiscal measures than by monetary
steps.
The Govt. adopt the following methods to control the
deflation situation:

Increase public spending

Reducing taxes
Stimulating private investment
Private consumption
increase the living standard of the people

STAGFLATION
Unemployment and inflation increase at the same time

Words of Michael Swan;

Stagflation can be described as a contraction or stagnation of a
nations output accompanied by rise in the price level.

Stagflation is a more serious problem than inflation.

When the economy is hit by declining output, it
depressed the economy of a whole country with
growing
unemployment.

CAUSES OF STAGFLATION
According to the modern economists, the main
cause of stagflation is the reduction in aggregate
supply.
The reduction in AS may be due to the following
factors;
Reduction in Labor supply
Increases in taxes
Resources costs

MEASURES TO CONTROL
STAGFLATION
Here are number of measures which can be adopted to slow
down the rise in the general price level and maintain the
general price level.
The should make every effort that minimum wages
are no
raised during stagflation.
The increase in money wages should be linked with
increase in productivity.
The personal and business taxes should be reduced to
bring down the costs of goods.
The Govt. itself should take up development
programs to
create jobs in the country

END

High School Economics, 3rd edition

Henry B. Stobbs, MFA
MACROECONOMICS, 7th. Edition
N. Gregory Mankiw
Tutorial written by:
Mannig J. Simidian
B.A. in Economics with Distinction, Duke University
M.P.A., Harvard University Kennedy School of
Government
M.B.A., Massachusetts Institute of Technology (MIT)
Sloan
School of Management