Inflation & Deflation

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# Inflation & Deflation - PowerPoint PPT Presentation

Inflation & Deflation. Reference 13.1 and 13.2. Aggregate=all together. Aggregate demand and aggregate supply considers the entire quantity of goods and services in an economy. The equilibrium price in aggregate supply and demand curves is called the price level. S1. D1. Price Level.

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## Inflation & Deflation

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Presentation Transcript

### Inflation& Deflation

Reference 13.1 and 13.2

Aggregate=all together
• Aggregate demand and aggregate supply considers the entire quantity of goods and services in an economy.
• The equilibrium price in aggregate supply and demand curves is called the price level.

S1

D1

Price Level

Q

Inflation/ Deflation

What is it?

an increase in the price level

a decrease in price level

How is it determined?

by comparing the CPI in different years and noting the change

CPI is higher=inflation

CPI is lower=deflation

CPI= Consumer Price Index

Last year’s CPI (based on 1984 prices)

\$216.17

• This year’s CPI

\$218.70

• Inflation rate

3.82%

Inflation rate = (CPI later year – CPI earlier year) ÷ CPI earlier year

Can be caused by supply-side shifts or demand-side shifts

woohoo!!

more people!!

more money!!

• Under what conditions would you expect to see inflation (rise in price level)?
• Under what conditions would you expect to see deflation (fall in price level)?

Inflation can be caused by an increase in aggregate demand

Inflation can be caused by a decrease in aggregate supply

oil

grain

Deflation can be caused by a decrease in aggregate demand

Deflation can be caused by an increase in aggregate supply

Simple Quantity Theory of Money
• If velocity and quantity of output (supply) are constant, more money in circulation leads to higher prices.

What does velocity mean?

velocity=the average number of times per year

a dollar is spent to buy final goods

Simple Quantity Theory of Money
• If velocity and quantity of output (supply) are constant, more money in circulation leads to higher prices.

M x V = P x Q

M = money supply

V = velocity

P = price level

Q = quantity of output

% change M = % change P

More working people

with

more money

(increase in aggregate demand)

rememberMonetary Policy?
• The goal is to maintain price stability and low unemployment.
Monetary Policy
• Fed is responsible for maintaining price stability and employment
• “Expansionary Monetary Policy”
• goal is to increase money supply
• to reduce unemployment
• to avoid deflation
• “Contractionary Monetary Policy”
• goal is to decrease the money supply
• to reduce inflation
So What?
• Negative Effects of Inflation
• hurts people on fixed incomes (the retired)
• hurts savers
• hurts lenders (helps debtors)
• hurts people who contract to be paid in the future
• makes financial decision making more difficult
• hedging = avoiding or lessening a loss by taking a counterbalancing action.
• buy gold or some other store of value besides money
So What?
• Negative Effects of Deflation
• Great Depression!
• uneven fall in prices
• job loss
• hurts debtors
• hurts property-owners
Stagflation
• stagnant (persistently high) unemployment

and

• inflation

What’s up with that?

• 1970’s US and other industrialized nations experienced stagflation
• erratic monetary policy: stop-and-go, on-and-off
• supply shocks (OPEC)
Review
• What are some possible causes of inflation?
• What are some possible causes of deflation?
• Why is the relationship between unemployment and inflation usually inverse?
• Why is inflation a problem?
Review
• How does the “the fed” use monetary policy to control inflation?
Homework