Transcript Inflation Inflation  Inflation at its simplest just means a “general increase in prices”.  A more complicated way to look at it is that inflation.

Inflation
Inflation

Inflation at its simplest just means a “general
increase in prices”.

A more complicated way to look at it is that
inflation is a decrease in the Purchasing Power
of your money.
 Purchasing
power means your money’s ability to
purchase goods and services
Measuring Inflation

We measure inflation by looking at ‘price
levels’ and ‘price indexes’.

Price level is an average of the prices of all the
goods and services made in one year.

Price Index is an average of the prices of a
certain set of goods
CPI

The most famous price index is the
“Consumer Price Index” or CPI

It is an index of the prices of a set of
items intended to represent the
“market basket” of a typical
consumer.

In other words, it’s an index of the
goods and services the government
thinks most people buy in a year.
Official CPI Composition
Determining the Inflation Rate

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Inflation Rate: the percentage change in price
level over time.
It is essentially the same formula as measuring
Economic Growth
Start with the CPI of the later year (CPI2)
Subtract from it the CPI of the earlier year (CPI1)
Divide by CPI1
Multiply by 100
((CPI2 – CPI1) ÷ CPI1) x 100 = Inflation Rate
Calculating the Inflation Rate
So if the CPI for 2003 is 184
 And the CPI for 2004 is 188.9
 What was the inflation rate?

((188.9 – 184) ÷ 184) x 100
 (4.9 ÷ 184) x 100
 .027 x 100 = 2.7%
 In other words the average price of
EVERYTHING rose by 2.7% in one year.

A Few More Terms

Core Inflation Rate: the rate of inflation
excluding food and energy prices.
 Used
because food and energy prices can
sometimes shift rapidly

Hyperinflation: inflation that is out of
control
What Causes Inflation?
There are several theories,
including 3 that the
government uses to fight
inflation.
 However, the simplest way
to understand it is The
Wage-Price Spiral

The Wage-Price Spiral
Let’s use Home Depot as an example:
•
HD employees want more money
•
HD gives pay raises.
•
To pay for higher wages, HD must raise prices
of its goods.
•
All the companies that buy HD goods must
raise their prices so they can afford HD’s new
prices
•
HD workers find their money doesn’t buy as
much at all other businesses.
•
HD employees want more money.
Effects of Inflation
Reduced purchasing power
Sometimes reduces income.
1.
2.
-
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You get a 4% raise.
Inflation raises prices 5% this year
You actually make less money this year than last
year.
Sometimes negates interest rates.
3.
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You put your money in an account that pays you
3.5% interest.
The interest rate for the year is 4.0%
The money in your account effectively shrunk.