Inflation

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Inflation

• A general increase in prices caused by too much
  money in the circular flow

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Imagine you have a job that pays 50 a day. You
are pretty happy with your job and your ability
to pay your bills with your income. At the end
of the work day you receive your 50 and stop at
the grocery store to buy dinner. When you get to
the grocery store, you find out that your can of
beeferoni is not 1.09 like it was yesterday, it
is now 49. What happened?
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Types of inflation

• Demand-Pull Inflation
• Too much spending chasing too few goods

• Cost-Push Inflation
• Supply shocks abrupt increases in the cost or
  raw materials or energy sources

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Hyperinflation

• Radical inflation money becomes worthless and
  is no longer used as a median of exchange?
  economic collapse and political chaos
• Examples Germany after the war, after break up
  of Soviet Union

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CPI consumer price index

• Indication of inflation calculated by sampling
  households and monitoring expenditures on
  specific goods and services
• Core CPI takes out food and energy
• CPI not perfect consumption patterns change,
  doesnt account for quality and hard to account
  for new products

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Downfalls of CPI

• Quality bias
• What happens when quality changes year to year?
• New product bias
• What happens when new products arent considered
  in CPI right away? (also price changes)
• Discounting and substitution
• What happens when we shop in new places?

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Fixed CPI calculation
Year Theatre tickets (quantity) Cinema tickets (quantity) Theatre ticket (price) Cinema ticket (price)
2005 25 12 40 15
2006 15 18 45 10
(25 Theatre tickets x 45) (12 Cinema tickets x
10) x 100 (25 Theatre tickets x 40) (12
Cinema tickets x 15)
105.5 or 5.5 inflation rate
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An alternative chain weighted CPI

• It implements weight shifting, which means the
  shift from one product to another due to the
  changed needs of the consumer.
• Suggested as a way for the government to save
  money

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Chain weighted CPI calculation
Year Theatre tickets (quantity) Cinema tickets (quantity) Theatre ticket (price) Cinema ticket (price)
2005 25 12 40 15
2006 15 18 45 10
(15 Theatre tickets x 45) (18 Cinema tickets x
10) x 100 (25 Theatre tickets x 40) (12
Cinema tickets x 15)
72.5 or 27.5 deflation
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Unexpected Inflation

• Unexpected inflation imposes costs on many people
  and benefits others because it arbitrarily
  redistributes purchasing power
• Inflation can reduce the rate of growth of
  national living standards because individuals and
  organizations use resources to protect themselves
  against the uncertainty of future price changes

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Redistribution Effects

• Nominal income the number of received as
  wages, rent, interest or profits
• Real income- measure of the amounts of goods and
  services nominal income can buy
• Real nominal income / price index
• COLA cost of living adjustment

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How are different people affected?

• Hurts savers and people on fixed incomes

• Helps people who borrowed money at a fixed rate

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MV PQ Equation of Exchange

• M Quantity of Money in the Economy
• V Velocity of Money
• P Price Level
• Q Total Final Output Produced

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