Transcript Chapter 14 Inflation

CHAPTER 14
INFLATION
Impact and Measurement
Causes and Cures
Inflation: Impact and Measurement
• Proverbs 23:5 and Revelation 6:5-6
• Inflation: is the term economists use to describe a sustained rise in the
average price level. The existence of inflation does not necessarily mean
that the price of every good is rising.
• Inflation: Losers and Winners: Losers: persons living on a fixed income,
creditors, savers, consumers. Winners: for almost every loser there is a
corresponding winner: (pension-holder vs. former employer) (Creditors
vs. borrowers) and (Savers vs. investors- banks).
• Cost of Living Adjustment: Currently many employers take future
inflation into consideration when developing pension plans. These plans
include a COLA, which adjusts payments upward as inflation causes
prices to rise. The Social Security Administration annually adjusts its
payments according to changes in the cost of living.
• Hyperinflation: reading pg 284
Measuring Inflation: GDP Deflator and
Consumer Price Index (CPI)
• GDP Deflator: Calculated by comparing the prices of ALL goods
and services from year to year, the GDP deflator is able to
measure the changes in prices of everything from hot dogs to
battleships. The problem with using the GDP deflator as a COLA
factor is that is measures changes in the prices of all goods in the
nation. If the price of military hardware rises while prices on
everything else remain level, the GDP deflator will still rise.
• Consumer Price Index (CPI): Governmental economists us the CPI
to measure the changes in the prices that affect a selected market
basket of goods and services. To calculate the CPI, economists
repeatedly measure the prices of approximately four hundred
goods and services that an average urban household purchases
over a base period (initial period of the survey). See Figure 14-1
the base period is that of the years 1982-1984.
Inflation: CPI
• Uses of the CPI: One of the major uses of the CPI is for
determining inflation rates. (Figure 14-1). The CPI also
allows economists to determine an individual’s purchasing
power. Many individuals and business firms have
recognized the eroding influence of inflation and have
accepted the CPI as the primary tool to index or adjust
wages, prices and interest rates.
• Indexing: a process of tying present wages and prices to
some adjustment figure to maintain a balance between
real wages and real prices. Ex/ the federal government
indexes social security payments using a cost of living
index based in the CPI.
Inflation: CPI
• Limitations of the CPI: 3 main reasons.
• A. first the CPI assumes that all urban households consistently
purchase, month after month, the same market basket of goods
and service, while in reality buying preferences change.
• B. the problem of adjusting price changes to quality changes (pg
287: Ex/ the washing machine of 1970 vs. 2012 washing machine).
• C. it tends to ignore the law of demand. As the price of a good
rises, ceteris parabus, people will tend to demand less of the good
and will purchase a less expensive substitute. Ex/ Buying a home
vs. Renting
Inflation: Causes and Cures
• Causes of Inflation: Figure 14-3 illustrates the intersection of a good’s
supply and demand curves determines its price. Only TWO situations
can cause a price increase. 1) a shift of the supply curve to the left (Fig.
14-4a: producer is producing less) or 2) a shift of the demand curve to
the right (Fig. 14-4b: buyers are demanding more).
• Total Supply and Total Demand Curves: Fig. 14-5. The GDP is used for
the Total Demand Curve. Since the intersection of the total supply and
the total demand curves determines the nation’s price level, there can
be only two possible explanations for inflation: 1) a decrease in the
nation’s supply of goods and services (leftward shift in the total supply
curve) or 2) an increase in the nation’s demand for goods and services
(rightward shift in the demand curve)
• #1 is called cost-push inflation and #2 is called demand-pull inflation.
Inflation: Causes and Cures
• Cost-Push Inflation: business firms begin the inflationary process
by charging higher prices, an action that shifts the total supply
curve to the left (Fig. 14-6 and 14-7 pg 289: Read and
Understand).
• Demand pull Inflation: inflation begins with an increase in
demand by consumers (whatever the reasons for the increase in
demand) and the demand curve shifts to the right.
• Money Growth: The root cause of inflation: a continual increase
in the money supply keeps the price level going up. Price increases
are but a logical result of the infusion of more $$$ into the
economy. If new money is not injected in to the economy,
business firms would be unable to pay higher wages and
consumers would be unable to pay higher prices. Ex/ Car and
filling the tires with air pg. 290.
Inflation: Causes and Cures
• Cures for Inflation: People try to stem inflation by implementing
wage-price controls or limiting the creation of money.
• Wage-Price Controls: Those who view inflation as a price
phenomenon have a simple solution: mike it illegal for business
firms to raise the prices of their products or the wages of their
workers. They advocate freezing in place the total supply and total
demand curves.
• The problem with wage and prices controls is that they cannot
work if the government continues inflating the money supply.
Imagine inflating a car’s tires but putting a barrier above the car
that will not allow it to rise (pg 291). Price controls creates an
artificial shortage for a product.
Inflation: Causes and Cures
• Limitation of Money Creation: If one believes that increases in the
money supply create an excessive demand for goods and services that
causes inflation, then the obvious solution is to limit the quantity of
money being created.
• Christians should want to support policies that curb inflation but
verification of the result of those policies is also important.
• 1 Tim. 6:6 “godliness with contentment is great gain”.
• A.W. Phillips: The Phillips Curve: discovered an extremely significant
statistical relationship between changes in wages and the prevailing rate
of unemployment. There is a tradeoff between the rate of inflation and
the level of unemployment.
QUESTIONS?