Inflation

I. Inflation

~ A rise in the general level of prices

~ Standard Inflation Rate : 2-3%

II. Measuring Inflation

A. Inflation Rate - Measures percentage increase in price level over time
~ Key indicator of economy's strength

i. Deflation - Decline in general price level

ii. Disinflation - Occurs when inflation rate itself declined

B. Consumer Price Index (CPI) - Measures inflation by tracking the yearly price of a fixed basket of consumer goods and services
~Indicates changes in the price level and cost of living

III. Solving Inflation Problems

a. Finding inflation rate using market basket data 

((current year market basket value - base year market basket value) / base year market basket value) x 100

b. Finding inflation rate using index prices

((current year price index - base year price index) / base year price index) x 100

c. Estimating inflation rate using the rule of 70

~ Rule of 70: Used to calculate the number of years it will take for the price level to double at any given rate of inflation

Years needed to double inflation = 70 / annual inflation rate

d. Determining real wages

(Nominal wages / price level) x 100

e. Finding real interest rate

i. Real interest rate = nominal interest rate - inflation premium

~ Cost of borrowing or lending money that is adjusted for expected inflation (always expressed as percentage)

ii. Nominal Interest Rate = 

~ Unadjusted cost of borrowing or lending money

IV. Causes of Inflation

a. Demand-Pull Inflation - Caused by an excess of demand over output that pulls prices upward

b. Cost-Push Inflation - Caused by a rise in per unit production cost due to increasing resource cost

V. Effects of Inflation

Anticipated - Ex. In a year, we're gonna lay off people. You see it coming.

Unanticipated - Ex. Just fired abruptly. It hits you like a freight train.

Hurt by Inflation

~ People on Fixed Income - Social security, etc.

~ Savers - People who save money

~ Lenders/Creditors

Helped by Inflation

~ Borrowers, because their debt would be repaid with cheaper dollars than those that were loaned out

~ Fixed Contracts - Rate cannot change