UNIT 3 MACROECONOMICS INFLATION https www youtube comwat

UNIT #3 MACROECONOMICS INFLATION https: //www. youtube. com/wat ch? v=T 8 -85 c. ZRI 9 o

INFLATION • Inflation is an increase in the average price level in the economy • Often described as too much money chasing too few goods • Deflation is the opposite of inflation; it’s a decrease in the average price level

MEASURING INFLATION • The Bureau of Labor Statistics (BLS) computes the consumer price index (CPI) each month to show changes in prices • The CPI is computed by pricing a “market basket” of goods and services and comparing the cost to a base year period

CALCULATING CPI Cost of market basket this year CPI= _______________ X 100 Cost of market basket in base period Practice: Basket this year $500 Basket in the base year $250 What is the CPI?

MEASURING THE RATE OF INFLATION Inflation rate= (CPI YR 2 -CPI YR 1) _________ CPI YR 1 X 100 Practice CPI last year 10 CPI this year 12 What is the inflation rate?

INTERPRETING CPI FIGURES • The CPI for November 2014 was 236. 151, it was 100 in the base period; prices have gone up 136. 15% since then

CAUSES OF INFLATION • Quantity theory: says too much money in the economy causes inflation; the money supply should be monitored and adjusted to grow with the economy • Demand-pull theory: argues that inflation happens when demand exceeds existing supplies • Cost-push theory: inflation results from producers raising prices to meet increased costs (such as wages) – Can lead to a wage-price spiral: rising wages cause higher prices which cause higher wages

COST-PUSH INFLATION

EFFECTS OF INFLATION • Reduces purchasing power of money • Those living on a fixed income see their income eroded by inflation; some incomes are adjusted with a COLA (cost of living adjustment) • It affects the amount of interest people make – If your savings account pays 5% interest but inflation is 4%, you’re really making 1% • 5% is the nominal interest rate • 1% is the real interest rate – Interest rates are set based on expected inflation; if expectations are wrong there will be winners and losers