Chapter Seven Inflation The Big Ideas The definition
Chapter Seven Inflation
The Big Ideas… • The definition and causes of economic growth. • The nature and cause of the business cycle. • The nature of unemployment and its measurement. • The definition of inflation and how it is measured. • The overall effects of inflation on wealth and output.
Defining Inflation • Inflation is when value of money decreases so prices increases. Inverse relationship between the value of money and prices. • Each dollar of income buys fewer goods and services compared to before. • Inflation reduces our "purchasing power. “ Inflation Video
Measuring Inflation • The main measure of inflation in Canada and the U. S. is the Consumer Price Index (CPI). • The government reports inflation rates each month and each year. • Governments also uses the CPI to adjust pension benefits and income tax brackets. • Rate of Inflation is found by comparing the year's CPI the CPI in the previous year. • (year's index - previous year's index) / (previous year's index) x 100 = Rate of Inflation
Canada`s Historical Inflation Rate
Two Types of Inflation • Demand-Pull Inflation – “Too much spending chasing too few goods. " – Usually, the price level increases due to too much spending, the economy cannot produce fast enough. • Cost-Push Inflation – Inflation that arises on the supply, or cost, side of the economy. – This type of inflation explains rising prices in terms of factors that raise per-unit production costs.
Nominal versus Real Income Nominal Income: The number of dollars you receive. Real Income: The amount of goods and services nominal income can buy, or its purchasing power. It is the nominal income adjusted for inflation. Real Income = (nominal income)/(price index, in hundredths)
Did you Actually get a Raise? • If nominal income rises at the same rate as the price index, purchasing power stays the same. • However, in most cases, not everybody's nominal income rises at the same rate. • Your Percentage Change in Real Income = (Percentage change in Nominal Income – Inflation).
Who Does Inflation Hurt Most? Fixed Income Earners Savers Creditors (Loan Money)
Who is Unaffected or Helped by Inflation? Flexible Income Earners Debtors (Borrow Money)
Anticipated Inflation • Inflation that is fully expected. • This is less harmful because income receivers may be able to avoid or lessen its effects. • Unanticipated or surprise inflation is more harmful. • If you were a creditor, and you knew there would be inflation, how would you adjust your interest rates?
Nominal and Real Interest Rates • Nominal Interest Rate = (Real Interest Rate + Inflation Premium) • Real Interest Rate = (Nominal Interest Rate – Inflation) • Inflation is good for borrowers, bad for creditors.
Test Preparation • Questions 9, 10, and 11 on Page 178.
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