Transcript Lecture 10

Inflation
Another economic instability
problem
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Meaning of Inflation
 Is the rise in general piece level.
 Not necessary that all prices are
increasing
 In periods of inflation, some prices
are rising while some are declining
 The most important: general price
level, and the increase to have an
affect
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Measuring Inflation
 Using CPI when price index measures
the general level of prices in the
economy.
CPI year A=(basket yearA)/(basket in base
year) X100
 Therefore,
inflation rate2000 =CPI2000-CPI1999 X100
CPI1999
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Types of Inflation
1. Demand Pull Inflation:
assume that the economy is at its full
capacity of production.
Assume that total spending is greater
than production level… what will
happen to price level?
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 Since all resources are fully employed,
production cannot respond to this
increase in demand.
 Therefore, outputs cannot be expanded
to meet demand
 This excess demand will bid up prices,
causing “demand-pull inflation”.
 “Too much spending for too few goods”
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2. Cost-Push Inflation:
 This is an increase in per-unit
production costs.
 Per-unit production cost =
Total input cost / units of outputs
 This will reduce profits and reduce
outputs firms willing to produce.
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 Thus, the economy’s supply of goods
and services declines and the price
level rises.
 Costs are pushing the price level
upward
 Sources: supply shocks: increase in
costs or raw materials, energy inputs,
wages…
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Redistribution Effects of Inflation
 Inflation hurts some, leaves others
unaffected
 That is, inflation redistributes real
income from some to others
 Who benefits and who gets hurt?
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terminology
Nominal and real income:
Real income =
nominal income/price index
 Real wage: purchasing power of
nominal wage (number of $$ received
as wages, rent, interest, or profits)
 Some people will be affected more
than others as inflation occurs
(redistribution effect)
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 The following rule tells us
approximately by how much real
income will change:
%ΔReal in Income = %Δ in nominal
income - %Δ in price level
 Anticipation and the effect of
inflation?
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Who is Affected by Inflation?
Unanticipated inflation hurts:
1. Fixed income receivers
2. Savers
3. Creditors
 Who is Unaffected by Inflation?
1. Flexible income receivers
2. Debtors
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Anticipated Inflation
 The redistribution effects of inflation
are less sever or can be eliminated
when people can expect inflation and
can adjust their nominal incomes to
reflect the expected price-level
increases.
 Save more now (consume less)
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Hyperinflation
 Is an extremely high rate of inflation.
 Agents expect inflation rate to even
gets higher, leading them to “spend
now”.
 May cause economic collapse
 Uncertainty about future prices
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