Macroeconomics Unit II: Inflation

Inflation

• rise in general level of prices
• standard rate: 2%- 3%

Inflation Rate

• measures the percentage increase in price level over time
• key indicator of economy's strength

Deflation

• decline in general price level

Disinflation

• occurs when the inflation rate itself declines

Consumer Price Index

• measures inflation by tracking the yearly price of a fixed basket of consumer goods and services
• indicates changes in price level and cost of living

Finding Interest Rate Using Market Basket Data

• ((current year market basket value) - (base year market basket value) / (base year market basket value)) x 100

Finding Interest Rate Using Price Indexes

• ((current year price index) - (base year price index) / (base year price index)) x 100

Estimating Inflation Using Rule of 70

• used to calculate the number of years it will take for price level to double at any given rate of inflation
• (years needed to double inflation) = (70/(annual inflation rate))

Determining Real Wages

• ((nominal wages)/(price level)) x 100

Real Interest Rate

• (nominal interest rate) - (inflation premium)
• cost of borrowing or lending money that is adjusted for expected inflation 
• expressed as a percentage

Nominal Interest Rate

• unadjusted cost of bond or loan money

Causes of Inflation

• Demand (Pull): caused by excess of demand over output that pulls prices upward
• Cost (Push): caused by a rise in per unit production cost due to an increase in resource cost

Effects of Inflation

• Anticipated: being put on notice or removal from a job
• Unanticipated: being directly told of last day on job

Who is helped by inflation?

• Borrowers (because the money they pay back will be paid with cheaper dollars than what they were loaned out)
• Fixed Contracts

Who is hurt by inflation?

• People on fixed income
• Savers
• Lenders/Creditors