inflation sfls problems

Inflation

(Part 3 – consequences)

Is Inflation Good or Bad?

2.) CPI – measuring Inflation

Inflation:

4.) Causes of Inflation

1.) Inflation Vocabulary

5.) Consequences of Inflation

3.) Problems of CPI

Part 1

Part 2

Part 3

Inflation

Is Inflation Good or Bad?

It’s a monster, but not everyone is hurt.

High and volatile inflation has economic and social costs.

- If people know it will happen they can protect themselves, but still has problems.

Expected Inflation


Unexpected Inflation

- This is the one that sucks most.

- Especially when it is volatile 挥发物 it makes it very hard to conduct business.

- People on fixed incomes hurt the most.

- Loans that have interest rates and have inflation expectations built in are affected.

- Also has the same problems as expected inflation but it’s now unexpected!

Vs.

- Your money buys less stuff!Falling purchasing power

Problems:


- Holding money as cash doesn’t have an interest rate. More trips to the bank may be necessary.

Shoe leather costs

Menu costs - Difficult for firms to change prices often.

Taxes distorted扭曲 - Taxes usually don’t count inflation, and can cause a larger burden 负担.

Inflation redistributes income - Can be unexpected and undesired!

Problems:



Shoe leather costs

The idea comes from the old days of having to walk back and forth to the bank a lot, it wore holes in

your shoes.(a type of opportunity cost)

Problems:



Some firms can change prices quickly. (low opportunity

costs to do so.)

Some firms is very costly to change their prices often.

(high opportunity costs to do so.)

Problems:



Not always desirable, sometimes redistributes taking income from poor people and giving more income to rich people.

Overall Inflation redistributes income arbitrarily and can be unexpected or not desired.


- Some people win – the ones getting the higher prices

(think oil/gas companies)

- Some people lose – the ones paying the higher prices

(think YOU!)


Inflation Winners:

Debtors

Many firms

Inflation Losers:

Government(sometimes)

Lenders

Some payers

Most savers

Inflation and uncertainty Do I spend today, or

save? Prices going up or not? What is happening to my purchasing power? ARRRGGHH!


Inflation Winners:

- The ones getting the higher prices.

example:

- oil/gas companies

Debtors - Pay back with less valuable moneyexample:- borrow money from the bank

Many firms

Inflation Losers


- Biggest debtor in the world (Debtors WIN!)- Can get high taxes revenue


Inflation Winners:Inflation Losers:

- The ones paying the higher prices. Falling real incomes.

example:

- you and me

- fixed incomes

Lenders - Get paid back with inflated dollars. (dollars that are worth less)

example:- banks, creditors

Some payers

Most savers - Saving is losing value over time.

InflationSucks…

To summarize so far…

- a sustained increase in the cost of living or the general price level leading to a fall in the purchasing power of money.

Inflation

- is measured by the annual percentage change in consumer prices.

Rate of Inflation


- when the rate of inflation becomes negative.

Deflation

- the value of money becomes worthless.Hyperinflation

- ………………………….hless.Stagflation

- measures the typical consumer’s cost of living with only the typical things that are purchased.

- the main way to measure inflation.

Consumer Price Index (CPI)


How the CPI Is Calculated:

- Government surveys consumers to determine what’s in the typical consumer’s “shopping basket.”


1.) Fix the “basket”

- Government then collects data on the prices of all the goods in the basket.

2.) Find the prices

3.) Compute the basket’s cost

-Use the prices to compute the total cost of the basket.

How the CPI Is Calculated:

- The CPI in any year equals:


4.) Choose a base year and compute the index

100 xcost of basket in current year

cost of basket in base year

- The percentage change in the CPI from the preceding period:

5.) Compute the inflation rate

CPI this year – CPI last year

CPI last year

Inflation

ratex 100%=

3.) Problems of CPI

*** The general problem is that CPI tends to overstate the actual increase in the cost of living.

- Introduction of New Goods

- Substitution Bias

- Unmeasured Quality Change

- Discount sales

Different parts of this theory that brings us to the conclusions we will work with:

Classical Dichotomy

Quantity Theory of Money

Neutrality of Money

Velocity of Money (V of Money) - the rate at which money changes hands.

v =P x Y

M

Equation:

Inflation and the Classical Theory

Long Run Aggregate

Supply (LRAS)

Price

level

GDP

LRAS

Y

P1

P2Therefore: With the quantity equation (fisher equation) if Vis stable that means an increase in M just means and increase in P and not Y, so in the long run we just have inflation only.

M x V = P x Y

Inflation and the Classical Theory

MS1

$1000

Value of Money, 1/P

Price Level, P

Quantity of Money

1

¾

½

¼

1

1.33

2

4MD1

EQ

price level

EQ value

of money

A

MS2

$2000

B

Then the value of

money falls,

and P rises.

Suppose the central

bank increases the

money supply.

2.) Money supply – demand diagram

How does this work? Short version:

At the initial P, an increase in MS causes excess supply of money.

People get rid of their excess money by spending it on g&s or by loaning it to others, who spend it. Result: increased demand for goods.

But supply of goods does not increase, so prices must rise.

Result from graph: Increasing MS causes P to rise.

2.) Money supply – demand diagram

Quantity Theory of Money

Price

level

GDP

LRAS

Y

P1

P2

Price

level

GDP

AD

SRAS

PE

LRAS

YN

SRAS1

Y1

P1

The bad kind of inflation because it involves lower output.

2.) Cost-Push

Negative supply shock


2.) Cost-PushReasons:

a.) Input costs rise - Raw material costs rise.

b.) Labor costs rise - Pay more for workers means increased input costs.

c.) Fall in the exchange rate - Raw materials imported

costs rise.

d.) Expectations of inflation

- If inflation is expected, raise prices even higher.

Price

level

GDP

AD

SRAS

PE

LRAS

YN Y1

P1

AD1

The good kind of inflation because it involves more output.

3.) Demand-Pull


3.) Demand-PullReasons:

a.) Growing economy - Demand rising faster then supply can keep up.i.) *wealth effect

b.) Fall in the exchange rate

- Demand internationally rising faster then supply can keep up.

c.) Expectations of inflation

- If inflation is expected, raise prices even higher.

- Your money buys less stuff!Falling purchasing power

Problems:



Shoe leather costs


Taxes distorted扭曲 - Taxes usually don’t count inflation, and can cause a larger burden 负担.



Inflation Winners:

Debtors

Many firms

Inflation Losers:


Lenders

Some payers

Most savers

Inflation and uncertainty Do I spend today, or

save? Prices going up or not? What is happening to my purchasing power? ARRRGGHH!

The EndThank you

inflation sfls problems

Education