Mr. Rey Belen

INFLATION

WHAT IS INFLATION?

• Inflation is a rise in the general price level and is reported in rates of change.

• Essentially what this means is that the value of your money is going down and it takes more money to buy things.

• The inflation rate is determined by finding the difference between price levels for the current year and previous given year.

• The answer is then divided by the given year and then multiplied by 100.

• To measure the price level, economists select a variety of goods and construct a price index such as the consumer price index (CPI).

• By using the CPI, which measures the price changes, the inflation rate can be calculated.

• This is done by dividing the CPI by the beginning price level and then multiplying the result by 100.

CAUSES OF INFLATION

• demand-pull theory

• which states that all sectors in the economy try to buy more than the economy can produce

Shortages are then created and merchants lose business. To compensate, some merchants raise their prices. Others don't offer discounts or sales. In the end, the price level rises.

• deficit of the federal government

• If the Federal Reserve System expands the money supply to keep the interest rate down, the federal deficit can contribute to inflation.

If the debt is not monetized, some borrowers will be crowded out if interest rates rise. This results in the federal deficit having more of an impact on output and employment than on the price level.

CAUSES OF INFLATION• cost-push theory

• which states that labor groups cause inflation (increase in wage rate and prices of raw materials)

If a strong union wins a large wage contract, it forces producers to raise their prices in order to compensate for the increase in salaries they have to pay.

• the wage-price spiral

• which states that no single group is to blame for inflation

Higher prices force workers to ask for higher wages. If they get their way, then producers try to recover with higher prices. Basically, if either side tries to increase its position with a larger price hike, the rate of inflation continues to rise.

• excessive monetary growth

• When any extra money is created, it will increase some group's buying power. When this money is spent, it will cause a demand-pull effect that drives up prices. For inflation to continue, the money supply must grow faster than the real GDP.

AS STATED IN THE ARTICLE "WHY DOES MONEY HAVE VALUE?", INFLATION IS CAUSED BY A COMBINATION OF FOUR FACTORS:

• The supply of money goes up.

• The supply of other goods goes down.

• Demand for money goes down.

• Demand for other goods goes up.

SEVERAL WAYS IN MEASURING INFLATION

• GDP Deflator

• Price index used to “deflate” or to transform nominal GDP to real GDP. This is an overall measure of behavior of all prices in the economy. GDP deflator captures the behavior of prices of most goods and services, whether they are going up or down, or by how much.

• CPI (Consumer Price Index)

• This is the most popular measure of inflation. It captures the prices of goods and services that consumers typically buy.

• WPI (Wholesale Price Index)

• PPI (Producer Price Index)

EFFECTS OF INFLATION

• The most immediate effects of inflation are the decreased purchasing power of the peso and its depreciation.

• Depreciation is especially hard on retired people with fixed incomes because their money buys a little less each month. Those not on fixed incomes are more able to cope because they can simply increase their fees.

• A second destabilizing effect is that inflation can cause consumers and investors to changer their spending habits.

• When inflation occurs, people tend to spend less meaning that factories have to lay off workers because of a decline in orders.

• A third destabilizing effect of inflation is that some people choose to speculate heavily in an attempt to take advantage of the higher price level.

• Because some of the purchases are high-risk investments, spending is diverted from the normal channels and some structural unemployment may take place.

EFFECTS OF INFLATION

• Finally, inflation alters the distribution of income.

• Lenders are generally hurt more than borrowers during long inflationary periods which means that loans made earlier are repaid later in inflated dollars.

IS INFLATION HARMFUL?• Too much inflation will ruin the economy but small levels of inflation will spur growth.

Inflation is very harmful to any economy because it can ruin the economy's development and growth and this is not suppose to be. Inflation is also very harmful to any economy because the people living in that economy might not survive the situation and this is when you see that an economy is affected and if nothing is done to it, it can cause an economy to collapse.

• Read more: http://wiki.answers.com/Q/Is_inflation_harmful#ixzz16prlKMI9

WHY DON'T PRICES DECLINE DURING A RECESSION?

• In the article titled Why Does Money Have Value we saw that changes in the level of prices (inflation) was due to a combination of the following four factors:

• The supply of money goes up.

• The supply of goods goes down.

• Demand for money goes down.

• Demand for goods goes up.

In a boom, we would expect that the demand for goods to rise faster than the supply. All else being equal, we would expect factor 4 to outweigh factor 2 and the level of prices to rise

• Since deflation is the opposite of inflation, deflation is due to a combination of the following four factors:

• The supply of money goes down.

• The supply of goods goes up.

• Demand for money goes up.

• Demand for goods goes down.

We would expect the demand for goods to decline faster than the supply, so factor 4 should outweigh factor 2, so all else being equal we should expect the level of prices to fall.

EXPLANATION…

•From the previous discussions, we saw that measures of inflation such as the Implicit Price Deflator for GDP are procyclical coincident economics indicators, so the inflation rate is high during booms and low during recessions. The information in the previous slide shows that the inflation rate should be higher in booms than in busts, but why is the inflation rate still positive in recessions?

•The answer is that all else is not equal. The money supply is constantly expanding, so the economy has a consistent inflationary pressure given by factor 1.

•While inflation rates are generally lower during recessions, we can still experience high levels of inflation through the growth of the money supply.

•So the key point here is that while the inflation rate rises during a boom and falls during a recession, it generally does not go below zero due to a consistently increasing money supply.

•A recessionary period with a high inflation rate is known as stagflation, a concept made famous by Milton Friedman.

WITH REFERENCE TO THE CIRCULAR FLOW MODEL OF THE ECONOMY EXPLAIN WHAT HAPPENS TO ECONOMIC GROWTH, UNEMPLOYMENT, AND INFLATION WHEN INJECTIONS EXCEED WITHDRAWALS OR LEAKAGES?

• According to Keynes, consumption, and thus injections, stimulate the economy. The new capital, injected into the private sector, causes businesses to prosper and grow more efficiently. As a result, businesses are more willing to retain many of their employees, driving unemployment down. Furthermore, as consumption continues to increase, businesses are going to raise their prices, causing inflation to rise.

Read more: http://wiki.answers.com/Q/With_reference_to_the_circular_flow_model_of_the_economy_explain_what_happens_to_economic_growth_unemployment_and_inflation_when_injections_exceed_withdrawals_or_leakages#ixzz16poMnOn8

DOES INFLATION HAVE ANYTHING TO DO WITH MAKING A DOLLAR TODAY WORTH MORE THAN A DOLLAR TOMORROW?

• Of course it does. Inflation is the devaluing of money over time. It is always displayed as a percentage.

• While inflation makes one peso today worth more than a peso tomorrow, it (inflation) is not the only reason for that. Even if inflation is 0%, a peso today is still worth more than a peso tomorrow, for a couple of reasons like1. if you can buy something today, you can enjoy it (one day) more than if you had bought it the next day2. by investing a peso today, you can earn interest, increasing the value of the peso.3. Perhaps, we will not be able to enjoy the worth of the peso tomorrow.

• Read more: http://wiki.answers.com/Q/Does_inflation_have_anything_to_do_with_making_a_dollar_today_worth_more_than_a_dollar_tomorrow#ixzz16ppUTKgy

WHAT IS THE RELATIONSHIP BETWEEN INFLATION AND UNEMPLOYMENT?

• There has been an inverse relation between rate of inflation and the rate of unemployment in an economy. The more the entrepreneur extends the employment opportunity the more he has to pay to that particular factor of production and the more payment to factor of production the increase in the cost of producing a unit will be observed and in order to maintain the profitability of the product the entrepreneur will inflate the price of that product. A similar process will be observed through out the economy when the government intends to create job. The price of products or services, where the workforce is installed, will increase hence an increase in the rate of inflation will be visible through out the economy.

• It can be concluded from the aforesaid explanation that when a government intend to lower down the rate of unemployment it had to bear the increase rate of inflation in the national economy.

Read more: http://wiki.answers.com/Q/What_is_the_relationship_between_inflation_and_unemployment#ixzz16ps9AjKx

THANK YOU…