Inflation
People hurt most by inflation
1. People on a fixed income (pensions,
retirement funds. Social Security does
adjust to inflation)
2. Producers (costs of inputs increase)
3. People who sign contracts w/o cost of
living adjustments
4. Consumers—wages don’t typically keep
up with price increases
5. People who loan money
People who may benefit from inflation
1. People who borrow money
2. Real Estate owners
3. Investors in “real” assets (antique cars,
art, etc)
Demand Pull Inflation
• Increase in AD beyond full employment of
resources AS
Price Level
AD1
AD
Output
Cost Push Inflation
• Increase in cost of inputs (shrinks supply)
AS1 AS
Price Level
AD
Output
Financial markets and unanticipated
inflation
• Borrowers Benefit (a loan for $10,000 is
worth less with inflation)
• Lenders Lose (banks are paid back, but
dollar is worth less)
• Those with money in savings accounts
lose
Product markets and unanticipated
inflation
• Producers and Consumers lose
• Producers can ↑ prices immediately to
adjust for ↑ in cost of inputs
• Consumers always lose
Labor markets and unanticipated
inflation
• Bosses Benefit (pay employees with
weaker dollar)
• Laborers Lose without contract
negotiations
Answer questions 1-11 on the
second page of your handout
• 1. Banks extend many fixed rate loans
• Answer: Lenders lose because they are
paid back with a weaker dollar
• 2. A farmer buys machinery with a fixed
rate loan to be repaid over a 10 year
period
• Answer: Borrower benefits because he
pays off his loan with a weaker dollar
• 3. Your family buys a new home with an
adjustable rate mortgage
• Answer: Unknown--If interest rates ↑ with
inflation, purchasing power stays the same
• 4. Your savings from your summer job are
in a savings account paying a fixed rate of
interest
• Answer: You lose because the money is
worth less than when you put it in the bank
• 5. A widow lives entirely on income from a
retirement pension
• Answer: Pensions don’t adjust to cost of
living. Social Security adjust to CPI.
• 6. A retired man lives entirely on income
from social security
• Answer: Unknown. If he buys more
medicine than are included in CPI he
loses.
• 7. The federal government has a
$5,000,000,000 debt
• Answer: The government is a borrower,
thus the government pays off debt with a
weaker dollar
• 8. A firm signs a contract to provide
maintenance services at a fixed rate for
the next five years
• Answer: Contract doesn’t adjust with
inflation. The firm will be receiving less
money for the same amount of work
• 9. A state government receives revenue
mainly from a progressive income tax
• Answer: As income ↑, people enter higher
tax brackets and pay a larger % of income
• 10. A local government receives revenue
mainly from fixed rate license fees
charged to businesses
• Answer: Government provides same
service for less money (weaker dollar)
• 11. Your friend rents an apartment with a
three year lease
• Answer: The friend benefits because
leases are like mortgages. Borrowers
Benefit.