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# Chapter 13 - PowerPoint PPT Presentation

Chapter 13 Inflation. Key Concepts Summary. ©2000 South-Western College Publishing. What is inflation?. An increase in the general (average) price level of goods and services in the economy. What is deflation?.

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Chapter 13Inflation

• Key Concepts

• Summary

An increase in the general (average) price level of goods and services in the economy

A decrease in the general (average) price level of goods and services in the economy

The Consumer Price Index

What is theconsumer price index?

The CPI is an index that measures changes in the average prices of consumer goods and services

The Bureau of Labor Statistics (BLS) of the Department of Labor

Price collectors contact retail stores, homeowners, and tenants in selected cities in the U.S. monthly

The BLS records average prices for a “market basket” of different items purchased by the typical urban family

Food and Beverages

Housing

Apparel and Upkeep

Transportation

Medical Care

Recreation

Education & Communication

All other goods & services

16.4%

39.8%

4.8%

17.0%

5.7%

6.1%

5.5%

4.7%

As people’s tastes and preferences change, some of the goods and services that go into the basket change

Current year prices are compared to prices of a similar basket of goods and services in a base year

A year chosen as a reference point for comparison with some earlier or later year

The numerator and the denominator of the CPI formula are the same in the base year

*BYP = cost of the market basket of products at base-year prices

CPI =

CYP

BYP

X 100

How is the pricesinflation rate computed?

The annual inflation rate is computed as the percentage change in the official CPI from one year to the next

*CPIY = Consumer price index in given year

*CPIPY = Consumer price index in previous year

ARI =

CPI - CPIPY

CPIPY

X 100

20

16

12

8

4

0

-4

-8

-12

1930

40

50

60

70

80

90

00

What is disinflation? prices

A reduction in the rate of inflation

• It can overstate or understate the impact of inflation for certain groups

• Does not measure quality

• Substitutes are ignored

A general rise in prices will shrink people’s income

What is pricesnominal income?

The actual number of dollars received over a period of time

What is real income? prices

The actual number of dollars received (nominal income) adjusted for changes in the CPI

*RI = Real income prices

*NI = Nominal income

*CPI = CPI as a decimal or CPI ÷ 100

RI =

NI

CPI

% prices in nominal income

_

%  in CPI

%  in real income

=

What is wealth? prices

The value of the stock of assets owned at some point in time

Inflation can benefit holders of wealth because the value of their assets tends to increase as prices rise

The rate of inflation is greater than your rate of income

They can win or lose depending on the rate of inflation

What is the pricesinterest rate?

Interest per year as a percentage of the amount loaned or lent

What is the pricesnominal interest rate?

The actual rate of interest earned over a period of time

What is the pricesreal interest rate?

The nominal rate of interest minus the inflation rate

Demand-pull

Cost-push

What is pricesdemand-pull inflation?

A rise in the general price level resulting from an excess of total spending (demand)

When the economy is operating at or near full employment

What is pricescost-push inflation?

A rise in the general price level resulting from an increase in the cost of production

Cost increases for labor, raw materials, construction, equipment, borrowing etc.

Yes, expectations can influence both demand-pull and cost-push inflation

What is hyperinflation? prices

An extremely rapid rise in the general price level

What is a priceswage-price spiral?

A situation that occurs when increases in nominal wage rates are passed on in higher prices, which, in turn, result in even higher nominal wages and prices

It is lower than some and higher than others

Average Annual Inflation Rates 1999 countries?

65%

52%

46%

17%

11%

2.6%

2.2%

Turkey

Romania

Mexico

Nicaragua

Greece

U.S.

Key Concepts countries?

Key Concepts countries?

• What is Inflation?

• What is the Consumer Price Index?

• Which goods and services are included in the CPI?

• How is the CPI computed?

• What is a Base Year?

• How is the Inflation Rate computed?

• What is Disinflation?

Key Concepts cont. countries?

• What does Inflation do to People’s Income?

• What is Nominal Income?

• What is Real Income?

• What is Wealth?

• How is Wealth affected by Inflation?

• How does Inflation affect Borrowers and Savers?

• What are the two basic types of Inflation?

Key Concepts cont. countries?

• What is Demand-pull Inflation?

• What is Cost-push Inflation?

• Do people’s Expectations affect Inflation?

• What is Hyperinflation?

• How does the U.S. inflation rate compare with other countries?

Summary countries?

Inflation is an increase in the general (average) price level of goods and services in the economy.

The consumer price index (CPI) is the most widely known price-level index. It measures the cost of purchasing a market basket of goods and services by a typical household during a time period relative to the cost of the same bundle during a base year. The annual rate of inflation is computed using the following formula:

*ARI = Annual rate of inflation price-level index. It measures the cost of purchasing a market basket of goods and services by a typical household during a time period relative to the cost of the same bundle during a base year. The annual rate of inflation is computed using the following formula:

*CPIY = Consumer price index in given year

*CPIPY = Consumer price index in previous year

ARI =

CPI - CPIPY

CPIPY

X 100

Deflation is a decrease in the general level of prices. During the early years of the Great Depression, there was deflation, and the CPI declined at about a double digit rate.

Disinflation is a reduction in the inflation rate. Between 1980 and 1986, there was disinflation. This does not mean that prices were falling, but only that the inflation rate fell.

The inflation rate is criticized because (1) it is not representative, (2) it incorrectly adjusts for quality changes, and (3) it ignores the relationship between price changes and the importance of items in the market basket.

Nominal income is income measured in actual money amounts. Measuring your purchasing power requires converting nominal income into real income, which is nominal income adjusted for inflation.

The real interest rate is the nominal interest rate adjusted for inflation. If real interest rates are negative, lenders incur losses.

% adjusted for inflation. If real interest rates are negative, lenders incur losses.  in nominal income

_

%  in CPI

%  in real income

=

Demand-pull inflation is caused by by pressure on prices originating from the buyers side of the market. On the other hand, cost-push inflation is caused by pressure on prices originating from the seller's side of the market.

Hyperinflation can seriously disrupt an economy by causing inflation psychosis, credit market collapses, a wage-price spiral, and speculation. A wage-price spiral occurs when increases in nominal wages cause higher prices and, in turn, higher wages and prices.

END inflation psychosis, credit market collapses, a wage-price spiral, and speculation. A wage-price spiral occurs when increases in nominal wages cause higher prices and, in turn, higher wages and prices.