Inflation

Inflation: is the rise of the general level of prices.

Inflation rate measures the percentage increase in the price level over time

-          Offers a key indicator of the economy’s health.

Deflation is a decline in the general price level

Disinflation occurs when the inflation rate declines

Consumer price index (CPI): measures inflation by tracking the yearly price of a fixed basket of consumer goods and services

-          Indicates changes in the price level and cost of living

Solving inflation problems

a.       Finding inflation rate  using market basket data: Current year market basket value – base year market basket value)/ base year market basket value  x 100

b.      Finding inflation rate using price indexes: Current year price index- base year price index / base year price index x 100

c.       Estimating inflation using the rule of 70:

-          used to calculate the number of years for the price level to double at any given rate of inflation

-          Years needed to double inflation = 70/ annual inflation rate

d.      Determining wages: real wages = nominal wages/ price level x 100

e.      Real interest rate : Nominal interest rate- inflation premium

Real interest rate is the cost of borrowing or lending money that is adjusted for inflation

-          Always expressed as a percentage

Nominal interest rate: the unadjusted cost of borrowing or lending money

Causes of inflation:

Demand pull inflation: caused by an excess in demand over output that pulls prices upward ex. Concert: the more demand= higher prices

Cost push inflation: is caused by a rise in per unit production cost due to increasing resource costs

Effects of inflation:

Anticipated inflation: expected to inflate

Unanticipated inflation: no one has an idea, no notice prior

Hurt By inflation:

People on fixed income: social security, scholarship, grant

Savers

Lenders and creditors: they get less money than they loaned

Helped by inflation:

borrowers: debt will be repaid with cheaper dollars than those loaned out