What causes inflation and what are the effects?

GOAL #2

LIMIT INFLATION

What is a $1 worth in 2017?

Soaring Prices Make it hard to be a Foodie:http://money.cnn.com/2014/04/15/news/economy/inflation-cpi/index.html?iid=SF_E_Lead

https://www.youtube.com/watch?v=UMAELCrJxt0

Prices: 1999 vs. 20161999 2016

Federal Minimum Wage $5.15 $7.25

Median Household Income $39,973 $44,600 (2015)

A Gallon of Milk $3.32 $3.98

Eggs $1.08 $1.33

Stamp $0.33 $0.47

A Gallon of Gas $1.17 $2.49

Median Cost of New Home

$195,800 $379,800

CPI Inflation Calculator $1.00 $1.44

http://www.thepeoplehistory.com/pricebasket.htmlhttp://www.1990sflashback.com/1998/economy.asp

1919-2013

� Sustained widespread increase in price levels

� Reduces the purchasing power of money

Inflation

1. The Government Prints TOO MUCH Money (QUANTITY THEORY)

3 Types of Inflation

• Growth in the money supply• Governments that keep printing money to pay debts

end up with hyperinflation.

Examples:• Germany after WWI. In 1923

inflation reached 30,000%

2. DEMAND-PULL INFLATION

DEMAND PULLS UP PRICES!!!• Demand increases but supply stays the same. • Correlated with lower unemployment• Sometimes a result of easy credit

What is the typical relationship between inflation and unemployment?

3. COST-PUSH INFLATION(aka supply-pull)

Higher production costs decrease in overall output and increase prices

A negative supply shock increases the costs of production and forces producers to increase prices.

Results in stagflation = stagnant economy with high inflation and high unemployment.

Examples: • 1970s: oil went from $2.59/barrel to $11.65.• Hurricane Katrina destroyed oil refineries and causes gas prices to go up. Companies that use gas increase their prices.

A Perpetual Process:1. Workers demand raises2. Owners increase prices to pay for

raises

3. High prices cause workers to demand higher raises

4. Owners increase prices to pay for higher raises

5. High prices cause workers to

demand higher raises 6. Owners increase prices to pay for

higher raises

The Wage-Price Spiral

Type of Inflation: Demand Pull or Cost-Push?

1. In her 2020 State of the Union Address, President Huynh calls for an increase in the U.S. military presence across the globe to combat a “threat to the sovereignty of the U.S. economy and trade routes.”

2. The Arab Spring of 2010 disrupts oil production and supplies worldwide. This causes OPEC and commodities speculators to raise crude oil prices to record levels.

3. The federal government raises the minimum wage to $16 an hour.

Consumer Price Index (CPI)

Measuring Inflation

BLS: Consumer Price Index

� Statistic that shows the average of the prices of all goods and services by tracking the prices of a specific basket of goods purchased by a typical

household (measures the cost of living) � PRICE LEVEL

How the Consumer Price Index Is Calculated

� Fix the Basket: Determine what goods the typical consumer buys.� FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, 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).

� Find the Prices: The BLS conducts monthly consumer surveys to find the prices of each of the goods and services in the basket for each point in time.

BLS CPI Data Collection

� Prices are collected every month in 87 urban areas using 6,000 housing units and 24,000

retail establishment. Prices include tax.

� Prices are obtained by personal visits or telephone calls

� Represent 1. Urban Wage Earners and Clerical Workers – 28% of the population

and 2. All Urban Consumers (includes professional, managerial, self-employed, short-term workers, the unemployed, retired

and those not in the LF – 89% of the population

� Price changes are averaged together with weights that represent the importance of spending for each population.

How the Consumer Price Index Is Calculated

� Choose a Base Year and Compute the Index:

� Designate one year as the base year, making it the benchmark against which other years are compared.

� Compute the index by dividing the price of the basket in one year by the price in the base year and multiplying by 100.

� CPI = current price

base period price

� Current base year = 1982-84, CPI = 100

� Compute the inflation rate: (π%)

The inflation rate is the percentage change in the price index from the preceding period.

� Inflation = CPI year 2 – CPI year 1

CPI year 1

X 100

X 100

CPI vs. Inflation Rate

CPI = Price Level – the cost of living

Inflation – the rate at

which prices are rising

Calculating the CPI and the Inflation Rate: An Example

Consumer Price Index Report

� Core-Inflation - the rate of inflation excluding the effects of food and energy prices.

Inflation

CPI Practice Problem

Calculate the CPI for the basket of all the items above.

((3.98 + $1.33 + $0.47 + $2.49)/($3.32 + $1.08 + $0.33 + $1.17))*100 = 140.169

A basket of goods that cost $100 in 1999, would cost $140.17 in 2016

Calculate the core-CPI rate

(0.47/0.33)*100 = 142.424

*Use 1999 as the base year.

1999 2016

A Gallon of Milk $3.32 $3.98

Eggs $1.08 $1.33

Stamp $0.33 $0.47

A Gallon of Gas $1.17 $2.49

Relative

Importance -

how the

average consumer spends his/her $$$

BLS: CPI, May 2017– All Items

Problems with the CPI

CPI may overstate the impact of inflation on the consumer

• Substitution Bias- As prices increase for the fixed market basket, consumers buy less of these products and more substitutes that may not be part of the market basket.

• Product Quality- The CPI does not account for improvements and decline in product quality. • The price of car has increased but so has its quality

(bluetooth, gps, etc)

CPI measures prices but not the increase in choices

• The CPI market basket may not include the newest consumer products.

Calculating the Inflation Rate(rate of change)

� = CPI year 2– CPI year 1

CPI year 1

CPI

2008: 215.303

2009: 214.537

2010: 218.056

2011: 224.939

2012: 229.594

2013: 233.049

2014: 234.812 (Dec)

2015: 237.945 (Sept)

X 100

� From 2014 to 2008� ((234.812 - 215.303)/ 215.303)*100 =

� From 2013 to 2014� ((234.812 - 233.049)/ 233.049)*100 =

9.1%

0.75%