INFLATION

Inflation is a general rise in the level of prices. Deflation is a decline in the level of all prices.

Inflation v. Deflation

Disinflation is a

slowing of price increases (inflation rate decreases)

Other terms

Hyperinflation is extreme,

rapid, and out of control inflation

Classic example in Germany: In 1922, the highest denomination was the 50 thousand Mark. By 1923, the highest denomination was 100 trillion Mark

That’s a 1.9 x 10^11% increase!!!

More terms

There are two major types of inflation. Demand-pull inflation is too many dollars, chasing

too few goods. Demand-pull inflation is caused by too much

aggregate demand

Types of Inflation

P

Q

D1D2

S

Cost-push inflation occurs when the cost of

producing goods rises; usually this is an increase in the cost of inputs.

This causes aggregate supply to decrease. This is more harmful to the economy because not

only does the price level go up, but the output or GDP declines.

Types of Inflation

P

Q

D

S1S2

There are several causes of inflation:

Wage-price spiral Government spending

Causes of Inflation

The wage-price spiral is when prices rise, causing workers to demand raises to pay the higher prices causing prices to increase again because the workers are paid more money;

This continues and we are in a wage-price spiral.

This is related to cost-push inflation because wages are paid for the labor input.

Causes of Inflation

Government spending too

much money causes deficit spending.

This is related to demand- pull inflation.

Causes of Inflation

Quantity theory of

money or inflation is what Monetarists believe.

The money supply should grow at a constant rate to equal the growth of the economy.

How the economy should work

dollar will buy less or

purchasing power decreases

Spending habits change

interest rates rise people won’t get

loans for big ticket items

Effects of Inflation

distribution of income is

altered lenders hurt and

borrowers are helped money paid back is worth

less

Effects of Inflation

reduces real wages of workers decreases the value of saving dollar is worth less

Effects of Inflation

Two ways to measure inflation are CPI and PPI. These are two types of cost of living

adjustment or “COLA’s.” They are automatic adjustments to wages

each year that takes into account the rate of inflation.

Measuring Inflation

Stagflation is a time of high unemployment

coupled with high inflation.

Stagflation