•Fluctuations in

Prices

Zimbabwean Dollars

At one point,

$1 = 621,984,228 Zimbabwean dollars.

• The Rate of Inflation is calculated as:

Inflationrate =

Last year’sprice index

This year’s price index

Last year’s price index-

* 100

• Inflation is an increase in the general level of prices.

• Between 1956 and 1965, the general price level increased at an average annual rate of only 1.3%.

• In contrast, the inflation rate averaged 9.2% from 1973 to 1981, reaching double-digits during several years.

• Since 1982, the average rate of inflation has been lower (3.1% from 1983-2006) and more stable.

The Inflation Rate, 1956-2006

• 1983-2006 averageinflation rate = 3.1 %

• Inflation rate

• 1956• 1960• 1965• 1970• 1975• 1980• 1985• 1990 • 2000• 1995

• 10

• 5

• 0

• 15

• 2005

• 1956-1965 averageinflation rate = 1.6 %

• 1973-1981 averageinflation rate = 9.2 %

Inflation, 1913 - 2014

(a)Inflation was highest just after World Wars I and II, and during the 1970s.

(b)Deflation occurred several times in the first half of the century and in 2009 as well.

International Inflation

Items 1970 2012

Pound of ground beef $0.66 $3.24

Pound of butter $0.87 $2.80

Movie ticket $1.55 $7.96

Sales price of existing home $23,000 $185,283

New car $3,000 $30,303

Gallon of gas $0.36 $3.48

Average hourly wage for a manufacturing worker

$3.23 $19.17

Per capita GDP $5,069 $43,063

Price Comparison, 1970 and 2012

• In 2012, $1 had about the same purchasing power as • 18 cents did in 1972

Consumer Price Index

The U.S. price level rose relatively

little over the first half of the

twentieth century

The upward slope reflects the high rate of inflation in the 1970s.

Year $ Spending Index

1 170 85

2 180 90

3 Base year 200 100

4 200 100

5 224 112

6 250 125

7 280 140

Year $ Spending Index

1 170 85

2 180 90

3 Base year 200 100

4 200 100

5 224 112

6 250 125

7 280 140

• Current year spending• Base year spending

• x 100

Creating a price indexCreating a price index

Year $ Spending

1 170

2 180

3 Base year 200

4 200

5 224

6 250

7 280

Year $ Spending

1 170

2 180

3 Base year 200

4 200

5 224

6 250

7 280

Calculating inflation using SpendingCalculating inflation using Spending

• 200 – 170• 170

• From year 1 to year 3

• = .18

• From year 3 to year 1

• 170 – 200• 200

• = .15

Year Index

1 85

2 90

3 100

4 100

5 112

6 125

7 140

Year Index

1 85

2 90

3 100

4 100

5 112

6 125

7 140

Calculating inflation using IndexCalculating inflation using Index

• 100 – 85• 85

• From year 1 to year 3

• = .18

• From year 3 to year 1

• 85 – 100• 100

• = .15

• From year 6 to year 7

• 140 – 125• 125

• = .12

Year $ Spending Index

1 170 85

2 180 90

3 Base year 200 100

4 200 100

5 224 112

6 250 125

7 280 140

Year $ Spending Index

1 170 85

2 180 90

3 Base year 200 100

4 200 100

5 224 112

6 250 125

7 280 140

Creating a price indexCreating a price index

measures the impact of price changes on the cost of a typical bundle of goods and services purchased by households.

Consumer Price Index

Eight categories of goods and services

(Source: www.bls.gov/cpi)

2. IPI2. IPI

1. PPI1. PPI

3. ECI3. ECI

prices paid for supplies and inputs by producers

prices of merchandise that is exported or imported.

wage inflation in the labor market

designed to measure the change in the average price of the market basket of goods included in GDP (a broader price index than the CPI).

Even though the CPI and the GDP deflator yield similar estimates of the rate of inflation.

• Year• CPI

• (1982-84 = 100)

• 1996• 1997• 1998• 1999• 2000

• 156.9• 160.5• 163.0• 166.6• 172.2

• 3.0• 2.3• 1.5• 2.2• 3.4

• 1.9• 1.7• 1.1• 1.4• 2.2

• GDP deflator • (2000 = 100)

• 2002• 2003

• 179.9• 184.0

• 1.6• 2.3

• 1.7• 1.8

• 104.1• 106.0

• 93.9• 95.4• 96.5• 97.9

• 100.0

• Inflation rate• (percent)

• Inflation rate • (percent)

• Source: http://www.economagic.com.

• 2001 • 177.1 • 2.8 • 2.4• 102.4

• 2005• 2006

• 195.3• 201.6

• 3.4• 3.2

• 3.0• 2.9

• 112.7• 116.0

• 2004 • 188.9 • 2.7 • 2.8• 109.4

• CPI 2005 to 2006

• 195.3 – 201.6• 195.3

• = 3.2

• GDP 2005 to 2006

• 112.7 – 116• 112.7

• = 2.9

There are 2 Kinds of Inflation

1. Anticipated inflation: A widely expected change in the price level.

2. Unanticipated inflation: An increase in the price level that comes as a surprise, at least for most individuals.

1. Substitution Bias1. Substitution Bias

2. Quality/New Goods Bias2. Quality/New Goods Bias

• Does not take into account that a person can substitute away from goods whose relative prices have risen.

• Does not take into account how improvements in the quality of existing

• goods or the invention of new goods improves the standard of living.

1. Hyperinflation1. Hyperinflation

Inflation in Controlled Economies

Brazil, Argentina, and Russia experienced hyperinflation and China and Nigeria had high inflation rates in the mid-

1990s.

Inflation in Controlled Economies

Brazil, Argentina, and Russia experienced hyperinflation and China and Nigeria had high inflation rates in the mid-

1990s.

2. Money loses value

2. Money loses value• increases in wages may lag behind

inflation for a year or two

• If the minimum wage is adjusted for inflation only infrequently, minimum wage workers are losing purchasing power from their nominal wages

Inflation and the Minimum Wage

• The federal minimum wage dropped more than 30% 1967 to 2010, • The nominal figure climbed from $1.40 to $7.25 per hour. • Increases in the minimum wage in between 2008 and 2010 kept the

decline from being worse

1. Savings1. Savings

2. Loans2. Loans

3. Wealth3. Wealth

4. Politics4. PoliticsMay cause changes

May increase

Are easier to repay

Lose value

1. Demand-Pull

1. Demand-Pull

2. Cost-Push2. Cost-Push

1. Demand-Pull

1. Demand-Pull

buyers demands greater than producers supply

Price

Quantity

P2

P1

Q1

D1

S1

Q2

New price and output

D2(increase in demand)

Orig. price and output

2. Cost Push2. Cost Push

sellers’ costs are passed on to buyers

Price

Quantity/time

P2

P1

Q1

D

S1(initial equilibrium)

Q2

S2(new equilibrium)

1. When a price, wage, or interest rate is adjusted automatically with inflation1. When a price, wage, or interest rate is adjusted automatically with inflation

2. Private Examples

2. Private Examplesa. COLA - When a price, wage, or interest

rate is adjusted automatically with inflationa. COLA - When a price, wage, or interest rate is adjusted automatically with inflation

b. ARM - When the inflation rate rises, the interest rate on a loan increases as well.b. ARM - When the inflation rate rises, the interest rate on a loan increases as well.

c. Contract adjustments - sellers are not locked into a low nominal selling price if inflationturns out higher than expected;

- buyers are not locked into a high buying price if inflation turns out to be lower than expected.

c. Contract adjustments - sellers are not locked into a low nominal selling price if inflationturns out higher than expected;

- buyers are not locked into a high buying price if inflation turns out to be lower than expected.

3. Government Examples3. Government Examplesa. Income Taxes - tax rates are now indexed to rise automatically with inflationa. Income Taxes - tax rates are now indexed to rise automatically with inflation

b. Social Security – rates automatically increase with inflation.b. Social Security – rates automatically increase with inflation.

c. Bonds- now interest payments are adjusted for inflation. c. Bonds- now interest payments are adjusted for inflation.

Questions for Thought:1. Suppose that the CPI was 150 at the end of

last year and 157.5 at the end of this year. What was the inflation rate during the year?

2. If decision makers anticipate an inflation rate of 3% at the start of a year and prices during the year rise by 7%, this is an example of a. anticipated inflation. b. an inflation rate higher than anticipated. c. an inflation rate lower than anticipated.

3. True or false: when the inflation rate is high and variable, decision makers will generally be able to anticipate year-to-year changes in inflation quite accurately.

• 4. How would an unanticipated 5 percent jump in inflation impact the wealth of: • a. Joe, who has a 30-year home mortgage at a

fixed interest rate • b. The McCoy's, who hold most of their wealth in

long-term fixed yield bonds

• c. Hanna, a retiree drawing a pension of a fixed dollar amount

• d. Jose, a heavily indebted small-business owner. • e. Mike, the owner of an apartment complex with substantial debt at a fixed interest rate• f. Tina, a worker whose wages are determined by

a 3-year union contract ratified three months

ago

• 1. Suppose that the consumer price index at year-end 2004 was 140 and by year-end 2005 had risen to 150. What was the inflation rate during 2005?

• a. 7.1 % • b. 10 % • c. 14.2 % • d. 50 %

• 2. Which of the following is true?• a. Anticipated inflation is an increase in the price level that comes

as a surprise, at least to most individuals• b. Unanticipated inflation is a change in the price level that is

widely expected.• c. Decision makers are generally able to anticipate slow steady rates of inflation with a fairly high degree of accuracy.

• d. Inflation will increase the prices of goods and services that households purchase but not the wage rates of workers