What do economists Look at when evaluating price changes over time?

Examining Price Fluctuations– Price Level

Aggregate Supply– Total amount of goods and

services produced throughout the economy

Aggregated Demand – Total amount of spending

by individuals and businesses throughout the economy

Inflation – Average price level

increases for all products in the economy

– AG Demand increases faster than AG Supply

– Price increases cause value of a dollar to decrease

Deflation– Decrease in price level

of all products in an economy

– AG Demand decreases faster that AG Supply

– Price decreases causes value of a dollar to increase

Purchasing Power– The amount of real goods and services that a dollar can

buy is called purchasing power. Purchasing power does not vary directly with inflation

Nominal value of dollar is the actual value. The real value is what it can buy. If I give you a dollar today and you save it until next year its real value will be less than its nominal value

Anticipated Inflation – inflation rate that we believe will occur

Unanticipated Inflation – inflation rate that comes at a surprise

Unanticipated Inflation hurts those that lend money (fixed rate loan is getting paid back with inflated money that buys less.

Lenders lend money to make money. They must take inflation into account. If unanticipated inflation occurs they are hurt because the interest rate they charged was not large enough.

Who is Hurt by Inflation?

– Fixed- Income People – Savers – Creditors

Who is unaffected or Helped by Inflation?– Flexible-Income

Receivers– Debtors

Rate of Interest Nominal rate of interest

– rate expressed in today's dollars Nominal Interest Rate = Real Interest + Inflation Premium

(expected rate of inflation)

Real rate of interest – nominal rate of interest minus the anticipated rate of

inflation Inflation causes interest rates to rise

COLA–Cost of living adjustment: an automatic increase

in income when inflation rate increases

Causes of Inflation Demand-Pull Inflation

– AG Demand increases faster than the economy’s productivity causing the price level to increase but real GDP stays the same

– Pulls prices even higher Increase in Money

supply and credit

Cost-Push Inflation – Producers raise

prices to cover the higher resource costs causing a rise in price and Real GDP falls

Price Expectation

Supply Shock- increase the cost of production for all or many firms

Measuring Inflation Consumer Price Index

(CPI)– Measure of the average

change over time in the price of a fixed group of products

– 1st Select a base year to measure price change

– Market Basket- bureau selects a sample of commonly purchased consumer items

Producer Price Index – Average change over

time in the price of goods and services bought by producers

– Based on some 3200 products

Inflation Rate – Monthly or annual

percentage change in price

IR= [(CPI year B- CPI year A) / CPI Year A] X 100

Hyperinflation- worst degree of inflation – EXAMPLE- Germany

after WWI

Effects of Inflation – Decrease purchasing Power of a Dollar – Decrease Value of Real Wages – Increased Interest Rates – Decreased Saving and Investing– Increased Production Costs