Inflation

Frederick University 2014

Definition

A process of irreversible increase in the overall price level, involving a change in relative prices

Typology

According to the form – open and hidden

According to the rate of price growth – moderate, galloping, hyperinflation

According to expectations anticipated and unanticipated

According to source – driven by MS or MD, by AS

Demand pull inflationCPI

Y

AD

AD’

Supply push inflation CPI

Y

ADAS

AS’stagflation

Measurement

GDP deflator Consumer Price Index (CPI)

GDP deflator Nominal GDP – GDP at current prices Real GDP – GDP at constant prices (base

year prices – chosen year) Index – the change in the value of an

indicator compared to its previous level, taken as a base (= 100)

GDP deflator =(Nominal GDP : Real GDP) х 100GDP deflator is a current year weighted

index

Consumer Price Index

Consumer basket Relative shares of goods in the

consumer basket - g CPI = [(P1A/ P0A)x g0A + (P1B/P0B)x g0B] x

100 Rate of inflation = [(CPI – 100)/100]x

100% CPI is a base year weighted index

CPI an example There are two goods in the

economy – movies and wine

Р of movies in 2010 г. = €5. Р of wine in 2010 г. = €4. Q of movies in 2010 г. =

400 Q of wine in 2010 г. = 2000 The cost of consumer

basket = 400 x € 5 + 2000 x €4 = =€ 10000

€ 2000 out of these €10000 were spent on movies. This makes 20% or 0.2 of all money spent on movies.

Thus, the relative weight (g) of movies in 2010 = 0.20

g of wine = 0.80 Р of movies in 2011 = €8 Р of wine in 2011 = €3 CPI = [(8/5) х 0.20 + (3/

4) x 0.80) x 100 = 93 Rate of inflation = = (93 -100)/100 x 100% =

= -7%If the CPI were above 100,

the rate of inflation would have been positive.

The Phillips curveRate ofinflation

U’

SRPC1

SRPC’

UVW

Z

LRPC

U*

Z’

W’