Inflation DefinitionInflation Definition

Inflation: ◦General increase in the general price level throughout an economy Doesn’t mean the price of every product is increasing

Nor does a price increase in one or a few products mean that there is inflation

Types of InflationTypes of Inflation

Demand-Pull InflationDemand-Pull Inflation: ◦Inflation caused by consumer demand for goods and services increasing faster than the ability of the economy to produce more goods and services.

Think about how an auction works…

Types of InflationTypes of Inflation

Cost-Push InflationCost-Push Inflation:◦Occurs if business supplies less of the goods and services because of increasing costs…causing the price level to rise

◦The increasing costs could result from higher costs of inputs or because businesses expect prices to go up and so produce less currently

◦Ex: Fuel Costs for Airline Industry; Rise in Rent/Energy/Wages for Businesess

Examples:Examples:

Minimum Wage in 1985 was $3.35

If the wage rose at the same rate of inflation, minimum wage today should be…….

$6. 66

However, minimum wage is $7.25 federalAnd Oregon’s is $8.80

What is the impact of inflation?What is the impact of inflation?

Effect 1: Decreasing Value of the Dollar◦Inflation reduces the purchasing power of the dollar…as price level rises each dollar can buy less

Effect 2: Increasing Interest Rates◦Lenders raise interest rates to ensure profit on loans

◦Businesses avoid borrowing to expand or make capital improvements

◦Consumers less likely to finance high-priced items

What is the impact of inflation?What is the impact of inflation?

Effect 3: Decreasing Real Returns on Savings◦Interest on savings tends to increase during inflationary times

◦Inflation worries people about drop in standard of living, retirement (ie. Fixed Incomes)

How is inflation measured? How is inflation measured?

Best measure is the Consumer Price Index (CPI)

Measures how much prices of necessary items are changing

Allows for a comparison of avg. prices for a group of goods over time

Avg. rate of inflation is 1%-3%

What goods and services does CPI What goods and services does CPI include?include?

Food and Beverages - “Market Basket”

HousingApparel Transportation Medical Care RecreationEducationCommunication

Who is hurt by Inflation?Who is hurt by Inflation?

Savers◦Households that have been saving money will see the real value of their savings decrease

People on Fixed Incomes◦Cost of living will increase, however, their income level will not…Causes a decrease in their STANDARD OF LIVING

◦Some people on fixed incomes have a COLA Cost of Living Adjustment (Social Security) that rises with inflation

ExampleExample

Suppose you earn $1000/ yr.

The Inflation rate increases 10%, therefore prices for goods increase. (A $1000 item will cost $1100)

Your $1000 will not buy what the $1000 could buy the previous yr.

Who is helped by inflation?Who is helped by inflation?

• Inflation helps people who borrowed at a fixed rate of interest

(the payment of the loan to be repaid will remain the same; however prices for other goods may have increased)

Expecting InflationExpecting Inflation

Expecting inflation is a self-fulfilling prophesy…WHY?

◦When consumers expect prices to go up, they buy more goods (Demand Shifts Right)…thus creating Demand Pull Inflation

◦When suppliers expect prices to go up, they will decrease supply (Supply Shifts Left)… thus creating Cost-Push Inflation