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Chapter 07:Infation
Copyright © 2013 by The McGraw-Hill Companies, Inc !ll rights reser"e# McGraw-Hill$Irwin
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Infation
• We recognize infation as the second othe two major macroeconomic
problems we can ace.• The core problems:
– What kind o price increases are reerred toas “infation”?
– Who is hrt and who is helped b! infation?
– What is an appropriate goal or “pricestabilit!”?
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"earning #bjecti$es
• %&'%(. )now how infation is measred.
• %&'%*. )now wh! infation is a
socioeconomic problem.• %&'%+. )now the meaning o “price
stabilit!.”
• %&'%,. )now the broad cases oinfation.
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-nawa! Infation
• In (*+ prices in /erman! more thandobled e$er! da!. – 0o one sa$ed1 in$ested1 or made long'rn
plans.
– 2rodction came to a halt3 nemplo!mentincreased b! a actor o (%.
– The econom! collapsed.
– 4ltimatel! 5itler came to power.
• 6imbabwe e7perienced a similar economicdisaster between *%%& and *%(%.
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87ercise
• The crrent price o a good is 9(.
• I its price dobles e$er! da!1 what
will its price be in (% da!s? *% da!s?• In (% da!s1 9(*.
• In *% da!s1 9*,1*;;.
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What Is Infation?
• Infation: an increase in the a$eragele$el o prices1 not a change in an!speci
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-elati$e 2rices
• The market mechanism cases theprices o indi$idal goods and ser$icesto rise or all > an essential marketnction. – Relative price: the price o one good
compared to the price o other goods. – !ers switch rom one good to another
when their relati$e prices di$erge.• Infation is a rise in the a$erage price o
all goods. – It is not a market nction.
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-edistribti$e 8@ects o
Infation• Infation makes some people worse
o@ and others better o@.
• There are price e@ects1 incomee@ects1 and wealth e@ects.
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8@ects o Infation
• Aome prices rise and some all.
• -ising prices reBire !o to reallocate !or
prchasing power to ensre that !o getthe most satisaction per dollar spent.
– Co might redce b!ing goods with higherprices and increase b!ing goods with lower
prices.• This can be seen b! the di@erence between
nominal income and real income.
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8@ects o Infation
• Nominal income: the amont o mone!income recei$ed in a gi$en time period1measred in crrent dollars.
• Real income: income in constant dollars3nominal income adjsted or infation.
• Co ma! get a raise Dnominal income
increasesE > bt i it does not rise as astas infation1 !or prchasing powerdecreases Dreal income allsE.
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-edistribtion o Income and
Wealth b! Infation• Price eects.
– Those who b! prodcts that are increasingin price the astest end p worse o@.
– Those who sell prodcts that are increasingin price the astest end p better o@.
– Those who b! prodcts that are increasing
in price the slowest end p better o@. – Those who sell prodcts that are increasing
in price the slowest end p worse o@.
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-edistribtion o Income and
Wealth b! Infation• Income eects.
– 2eople with nominal incomes rising more
slowl! than infation end p worse o@. – 2eople with nominal incomes rising aster
than infation end p better o@.
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-edistribtion o Income and
Wealth b! Infation• Wealth eects.
– Those who own assets that are declining
in real $ale end p worse o@.
– Those who own assets that areincreasing in real $ale end p better
o@.
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Fone! Illsion
• Money illusion: sing nominal dollarsrather than real dollars to gage changesin oneGs income or wealth.
• 87ercise: – In the “good old da!s” a mo$ie ticket was %
cents and the minimm wage was 9(.%%.
– Hompare the prchasing power o theminimm wage toda! to the “good old da!s.”
– Co cold b! two mo$ie tickets with onehorGs work beore1 bt not now.
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87ercise in Fone! Illsion
• The infation rate in (;% was (+..
• In (& !or income was 9(%1%%%.
• In (;% !or income was 9((1%%%.
• Jid !or prchasing power increase?Jecrease? Ata! the same?
• JecreaseK Cor income went p (%while prices went p (+..
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Facro HonseBences o
Infation• 4ncertaint!: not knowing the prices o
goods in the tre makes prchasingand prodction decision making mch
more diLclt.• Apeclation: decisions will shit rom
standard economic acti$it! to betting onthe tre prices o goods.
• racket creep: in a progressi$e ta7s!stem1 when nominal incomes rise1 theta7pa!er gets pshed into a higher ta7bracket.
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5!perinfation
• yperinfation: infation rate in e7cess o*%% percent1 lasting at least ( !ear.
• Apending accelerates and prodction declines.
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Jefation
• !efation: a general decrease in a$erageprices.
•
This has redistribtion e@ects that are jstthe opposite o those or infation.
• This has macro conseBences also. – Aellers are relctant to stock in$entor!.
–
!ers are relctant to b! now. – sinesses are relctant to borrow nds or
in$est.
– Incomes all1 and asset $ales decrease.
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Feasring Infation
• Feasring infation ser$es twoprposes.
– /aging the a$erage rate o infation. – Identi!ing its principal $ictims.
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Honsmer 2rice Inde7 DH2IE
• Consumer price inde" DCPIE: ameasre Dinde7E o the a$erage price o
consmer goods and ser$ices. – 4sed to calclate the infation rate.
• Infation rate: the annal percentagerate o increase in the a$erage price
le$el.
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Hreating a 2rice Inde7
• Aelect a “market basket” o goods: astandardized list o goods andser$ices cstomers sall! b!.
• Aelect a base !ear: the reerence !earwhose dollar $ale will be sed.
• Aet the price inde7 in the base !ear
alwa!s eBal to (%%.• Feasre the prices or the basket o
goods in both the crrent !ear and inthe base !ear.
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Hompting a 2rice Inde7
• asket price in the base !ear M 9N1%%%.
• asket price in the crrent !ear M 9N1N%%.
• Hompte the price inde7 DH2IE or the crrent !ear: – OP(%% M 9N1N%%P9N1%%%
– O M DN1N%% 7 (%%EPN1%%%
– O M ((%• H2I in the crrent !ear is ((%.
• = H2I o ((% indicates that prices in the crrent!ear are (% higher than prices in the base !ear.
Price inde" in current year #as$et price in current yearPrice inde" %ase year & #as$et price in %ase year
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87ercise
• In *%%N H2I was abot *%%.Q• Q (;+ was the base !ear.
• In (;+ H2I was abot (%%.Q
• These two H2I
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#ther Feasres o Infation
• Core infation: changes in H2I1e7clding ood and energ! prices.
• Producer price inde" 'PPI(: changes in the a$erage prices atintermediate steps o prodction.
•
)!P defator: changes in prices o allgoods and ser$ices inclded in /J2.
– 4sed to correct nominal /J2 to real /J2.
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Hompting Infation -ate rom
H2I
• H2I in *%%N was *%(.N.
• H2I in *%% was (.+.
• Hompte the infation rate or *%%N:
• Infation rate M D*%(.N'(.+E7(%%P(.+M +.*+
CPI year 2 – CPI year 1 Inflation rate = X 100 CPI year 1
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The /oal: 2rice Atabilit!
• Price sta%ility: the absence osigni
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The /oal: 2rice Atabilit!
• Feasrement concerns.
– We are seeking price stabilit! at the
lowest rate o nemplo!ment. – Rrom !ear to !ear1 there are Balit!
impro$ements in the basket o goods.
– 0ew prodcts change the content o thebasket o goods we b!.
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The 5istorical -ecord
The highest and lowest annal infation rates since WW* are identi
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Hases o Infation
• !emand*pull infation: resltsrom e7cessi$e pressre to b! on
the demand side o the econom!. – = booming econom! creates shortages.
– Too mch mone! pmped into theeconom! b! the Rederal -eser$e.
• Cost*push infation:
de to higherprodction costs ptting pressre onsppliers to psh p prices.
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2rotecti$e Fechanisms
• Cost o+ livin, allo-ances 'C/(: nominal incomes are inde7ed to
atomaticall! rise at the same rate asinfation.
• d1usta%le*rate mort,a,e 'RM(:
interest rate on a mortgage risesalong with infation so that lenders donot lose mone!.
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The 8conom! Tomorrow
• The $irtes o infation. – = little infation might be a good thing.
•
The challenge or tomorrow is to
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-e$isiting the "earning
#bjecti$es• %&'%(. )now how infation is measred.
– Infation is measred b! changes in a price
inde7 sch as the consmer price inde7DH2IE.
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-e$isiting the "earning
#bjecti$es• %&'%*. )now wh! infation is a
socioeconomic problem. – Infation redistribtes income b! altering
relati$e prices1 income1 and wealth. – Aome people actall! gain rom infation1
whereas others s@er a loss o real income orwealth.
– Infation creates ncertaint! and speclationand detracts rom prodcti$e acti$it!.
– H#"=s and =-Fs help protect some peoplerom infation.
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-e$isiting the "earning
#bjecti$es• %&'%,. )now the broad cases o infation.
– Infation is cased either b! e7cessi$e
demand D“demand'pll” infationE or b!strctral changes in sppl! D“cost'psh”infationE.