Price Level Summary An increase in price level

Price Level

Summary An increase in price level reduced the purchasing power of money. A 2. 5 to 3 percent yearly increase in normal Increases in overall price level are due to 1. inflation caused by expansion of money supply (too much money chasing too few goods. ) all 2. cost push (debatable and not inflation) - average 3. demand pull (can be caused by inflation) average Measured using a consumer price index- will collect prices on a “basket” of goods and services and compare their current prices with the price of the market basket of base year. If both prices and wages rise – no big deal. But if income does not rise it can hurt people. Income- wages, government payments, interest on loans, and savings The people hurt must by inflation 1. Savers 2. Lenders 3. Fixed income 4. Those who wages don’t adjust.

Why do prices change?

Cost-Push (least likely cause of rising prices in the aggregate market) Cost-Push - The cost of production increases and their businesses feel that they need to raise their prices. This is linked to the wage-price spiral. As wages go up, prices go up, as prices go up employees ask for higher wages. Many economist dispute this notion because while cost-push may explain the rising prices of a specific product it cannot explain overall price levels. As some prices increase other decreaseall of the time. Fallacy of Composition- what is true of the part must be true of the whole. Happens in specific markets all the time but Unlikely to cause price level to rise in the aggregate market. Exception is oil. PL AS 2 AS 1 Ad 1 GDP/Y

Demand-Pull (Possible but some say temporary – supply catches up) Demand Pull- excessive growth of aggregate demand resulting from excessive growth of the money supply PL AS 1 Ad 2 Ad 1 GDP/Y

Inflation Will Cause prices to rise for everything Monetary Policy- “Too much money chasing too few goods. ” There are several ways to measure inflation—but the most common are the Consumer Price Index and the Producer Index. The CPI is the most commonly reported—it measures the changing prices of about 400 goods and services that people commonly consume. If this “basket” of goods and services goes up in price, we have inflation. Simple enough. But every increase in prices is not cause for alarm. In fact, a certain amount of inflation is actually a good sign. It means that most people are employed, have money in their pockets, and are willing to spend it. Most economists think that 2. 5 -3% inflation is acceptable. When it rises above this level, they begin to worry.

Why does the dollar bill have value?

Why was the dollar bill kept?

The Role of Money serves 3 functions. . . Medium of Exchange. Store of value. Measure of value.

Your parents have told you that money doesn’t grow on trees. But if it did what would happen to prices? Why?

First in your groups and then with the class review the following questions.

Now time for a Game We live in the Land of Hungry In this nation the only good or service that is produced and consumed are two mini-candy bars. The mechanism of exchange is an auction. I will sell the candy bar to the highest bidder. Please draw the following chart in your notebooks as I give your money. 1 2 3

Year 1 All students earn 1 dollar GDP two candy bars Price of Candy bar Year 2 (I can give you change) All students earn 5 dollars Year 3 ( I can give you change) All students earn 10 dollars Assuming that this simple model is an accurate depiction of the relationship between GDP, money supply, and price. What happens when the increase of money supply exceeds the increase in GDP? Prices Rise

MV= PQ M- Money Supply V- Velocity of Money (how many transactions are made. ) P- Price level Q- Quantity of goods and services (output) If the money supply increases and velocity and Quantity produced (output) have stayed the same, then what must happen to price in order for the equation to remain equal? If the money supply increases at a rate that is higher than the increase in GDP, we will see an increase in price. Money Supply > GDP = higher prices Money Supply < GDP = lower prices Money supply rule (Milton Friedman) Money supply increases/decreases = GDP increases/decrease

The inflation rate is the percent of increase in the price level of goods and services from one month or year to the next. In other words Inflation reduces the purchasing power of money.

Inflation rates in the United States 1999 -2013 http: //www. usinflationcalculator. com/inflation/historical-inflation-rates/

The cost of living is indeed going up—in money terms. What really matters, though, isn't what something costs in money; it's what it costs in time. Making money takes time, so when we shop, we're really spending time. The real cost of living isn't measured in dollars and cents but in the hours and minutes we must work to live. American essayist Henry David Thoreau (1817 -62) noted this in his famous book, Walden: "The cost of a thing is the amount of. . . life which is required to be exchanged for it, immediately or in the long run. "

1951 Price per a pound of chicken was $0. 60 Price for a 6 lb. chicken was $3. 60. Min. wage was $0. 75 per hour How many hours of labor was needed to earn enough for the 6 pound chicken. $3. 60 / $0. 75 per hour= 4. 8 hours of work 2018 Price per a pound of chicken is $0. 98 Price for a 6 lb. chicken is $6. 00 Min. wage is $7. 25 How many hours of labor is needed to earn enough for a 6 pound chicken? $6. 00 / $7. 25=. 83 hours or 50 minutes

As long as income can adjust raising prices shouldn’t be an issue. Income in this sense meaning the following: Wages Interests from savings Interest on loans Income from government such as social security

Who is hurt the most by inflation? Those on fixed incomes Those who lend money – Interest rate must adjust Those who are on salary that isn’t linked to inflation or whose wages don’t keep up with inflation. Those who save their money- It cannot buy as much tomorrow as it can today

How does the Federal Reserve create money or change the money supply? The incentives the banks to lend more or less depending on the situation. Changing the Discount Rate (providing loans to banks at a lower or higher interest rate). Changing Reserve requirements Buys securities in open bond market or Sells securities in the open bond market and this will lower interest rates. Quantitative Easing buying up financial assets of private banks. This disrupts the natural money markets (more on this later)

Economic cost of inflation 1. Loss of purchasing power If the price of a guitar was $200 one year. A student saved his money for an entire year to buy the guitar. He came back to the store the following year to see that the price is now $220. - Hurts those on fixed incomes the most. - Wages have to keep up with inflation 2. Higher interest rates- real interest rate is the nominal interest rate- the inflation rate= a real interest rate 10% interest rate- 4% inflation rate= 6 % real interest rate Dollars worth less tomorrow than today- slows lending 3. Loss of efficiency- many economist consider uncertainty about prices to be a bigger problem than the others. Buyers and sellers don’t have enough information to make the most efficient decisions.

Are you to blame for inflation and high prices? 1. You may not want prices to rise on what you buy, but do you want prices to increase on what you supply (wages)? 2. Can you think of any programs that the government provides that you would want to keep or maybe expand upon? How would the average citizen answer? 3. In general would you rather see the government increase taxes or decrease taxes? How would the average person answer? 4. If it is politically correct for people in government to cut taxes and expand programs at the same time. How do you suppose people in the government make up the difference?

According to some economist, inflationary policies can be considered a hidden tax. How can this be?

What about deflation (when price level fall)? It is worse People stop producing Demand drops because employers lay of workers and business won’t borrow. Almost every major economic crisis has been preceded by a of period deflation.

Summary Inflation is the overall increase in price levels- in other words a reduction of the purchasing power of money. A 2. 5 to 3 percent yearly increase in normal Increases in overall price level are due to 1. expansion of money supply (too much money chasing too few goods. ) 2. cost push (debatable and not inflation) 3. demand pull (can be caused by inflation) Measured using a consumer price index- will collect prices on a “basket” of goods and services and compare their current prices with the price of the market basket of base year. Both prices and wages rise – no big deal. But if income does not rise it can hurt people. Income- wages, government payments, interest on loans, and savings The people hurt must by inflation 0 1. Savers 2. Lenders 3. Fixed income 4. Those who wages don’t adjust.