Inflation

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					Inflation
Inflation is bad news!

          will destroy the
 Inflation
  strongest of economies
 Problem we face as a nation
 Has damaging effects-
  government watches for signs
         is an increase in the
 Inflation
 average price level for goods
 and services across an
 economy
 Let’s say the price of tires is
  rising rapidly
 Perhaps there is a rubber
  shortage causing the increase,
  or maybe people are simply
  buying a lot of radials
 Both of these situations can
  cause a price increase
A   rise in the cost of one product
  is not a problem for the United
  States as a whole
 But what if the price of tires,
  groceries, toys, wood, cars,
  steel, and everything else for
  that matter, were on the rise?
 Families  would have a harder
  time living within their budget
 Even worse, companies would
  have a difficult time planning for
  their future
 No  one could predict next
  year’s prices
 Consumers would get nervous,
  and corporations would stop
  hiring and buying equipment
 People  tend to spend their
 money more vigorously in an
 inflationary economy, because
 they are afraid their money will
 lose value
 In the late 1970’s, annual
  prices were increasing at a rate
  of 13% per year
 That means that a car that cost
  $10,000 this year will cost
  $11,300 next year
A  $100 grocery order will
  increase by another $13.
 Because bank interest rates
  take time to keep up with such
  devaluation of the dollar, saving
  becomes less and less
  common for the consumer
 People   simply want to spend
 before their money loses any
 more value, especially for big
 ticket items like cars and
 appliances
 This rapid spending prompts
 retailers to continue to raise
 prices in the face of the
 consumer frenzy
 All in all, inflation creates more
  inflation
 People realize that prices are
  increasing and respond by
  spending their money more
  quickly
 Inflation   should be nipped in
  the bud
 If it is seen that the Consumer
  Price Index (CPI) and other
  indicators rose from 1.5 to 1.8
  % they would take measures to
  stop the trend
 Inflation  breeds more inflation
 Once it gets started, it is most
  difficult to stop it
   http://inflationdata.com/inflation/Consumer_P
    rice_Index/HistoricalCPI.aspx
   Consumer Price Index information
 National rate of inflation has
  been around 1.5 to 3% each
  year
 Bureau of Labor Statistics
  publishes two figures every
  month that are closely watched
 Consumer     Price Index (CPI)
 sample of 80,000 of the most
 commonly bought consumer
 goods from rental housing,
 utilities, food, clothes,
 entertainment, and health care
 Totalis compared to a base
 year (currently 1984) and a
 number of figures are
 calculated for various regions
 around the country (had been
 1982)
 Producer   Price Index (PPI)-
  measures the different prices of
  goods at all stages of the
  production process
 Figures are compared to a base
  year- tally of products is kept
 Worker    has to earn more
  money to keep up the standard
  of living that he or she had last
  year
 Inflation will cause a rise in the
  price of most goods and
  services
 Itwill simply cost more to run a
  household
 Professions have to keep up
  with inflation by offering
  workers cost of living
  increases
 Many  labor contracts and
 government programs like
 social security are directly ties
 to cost of living adjustment
 figures provided by the CPI
 When   prices reach a high
 enough point, consumers, tired
 of their wages not keeping up
 with the rising prices, may
 decide to stop buying all
 together to wait out the storm
 The  result will be a severe
  slowdown of the economy
 Lack of sales will force factories
  to shut their doors and existing
  companies to curtail production
 Jobs  will soon be lost
 Potential result of even a minor
  bout with inflation is a serious
  and prolonged depression
  where the consumer is too
  afraid to spend any money
 Inflationhas two ways of
  getting started
 It can come from the supply or
  our economy or the demand
Supply Side Inflation

 Resource   prices in our
  economy go up for various
  reasons
 These increased prices can
  force up the cost of other
  consumer and producer goods
 Inthe Mid 1970’s, OPEC
  countries imposed an embargo
  on the United States
 Price of a barrel more than
  doubled forcing the prices of
  every product in our country
Demand Side Inflation

 People  buying too many goods
 In essence, there are too many
  dollars chasing too few goods
 Our producers cannot keep up
  with consumer demand, and
  they raise the prices
 But how do we keep people
  from buying things?
 And wasn’t a hot economy a
  good thing?
 Government  watches how
 much people are buying (called
 aggregate demand) and how
 much factories are producing
 (called aggregate supply)
 Ithas been mentioned that
  once inflation starts, it is very
  difficult to stop
 One major cause of this is due
  to a situation called the wage
  price spiral
 When   prices begin to rise,
  workers will begin to demand
  higher wages
 Suppliers can do this only if
  demand is strong enough to
  allow them to do so
 Ifworkers eventually get the
  extra money, they will tend to
  spend that quickly if they
  believe that prices will continue
  to rise
 Store   owners will notice the
  increased sales or the higher
  labor costs and then raise
  prices even more
 This is why it is vital to catch
  inflation before it starts
 Ifinflation is left unchecked,
  people will eventually be
  unable to afford any products
 Banks will raise interest rates
  higher to ensure profits
 With inflation of 13% in 1980,
  banks offered rates on home
  mortgages of almost 20%
 This brought the construction
  and car industries to their
  knees
 Nobody  like the prospect of
 paying the interest that came
 with an inflationary economy
 Worstcase scenario comes
 when the government ignores
 the warning signs like a rising
 CPI and product shortages
 Ifinflation is left completely
  unchecked and the money
  supply continues to grow too
  quickly prices can rise most
  rapidly
 Germany    in the 1920’s printed
 billions of marks to pay back
 other countries for the
 reparations demanded in the
 Versailles Treaty
 Markets responded to the flood
 of cheap money by jacking up
 prices to unbelievable heights
 Imagine  that this week when
  you buy a loaf of bread, it costs
  $1.00
 When you go shopping next
  week, you are amazed to find
  that the price has risen to
  $50.00
 People  had to carry baskets full
  of money just to buy their daily
  bread
 Hyperinflation eroded the
  confidence the German people
  had in their government
 Theirsociety had to deal with
 the chaos. This is one of the
 reasons that Hitler rose to
 power
 Deflationis a condition where
 the average prices for goods
 and services falls across the
 economy
 Inthe late 1800’s, farmers who
 were already hit hard by
 plummeting prices due to
 automation, also had to deal
 with the gold backed currency
 that steadily increased in value
 (because the growth of the
 money supply did not keep up
 with the growth of the
 economy)
 Their crop prices fell even
  further
 When they needed to borrow
  money to save their farms,
  banks- noticing the scarcity of
  money- raised interest rates as
  high as 80%
 Today,   for many reasons, we
  prefer a controlled amount of
  inflation around 1 to 3%
 Don’t confuse deflation with a
  situation called disinflation
Disinflation

 Rate  of inflation falls from a
  higher rate to a lower rate
  without becoming deflationary
 When inflation rates fell from
  13% in 1980 to 4% in 1985, it
  was said that the dollar was
  “disinflating”
 What if the unemployment that
 usually comes with a severe
 period of inflation continues for
 a prolonged period of time?
 We    are stuck with high inflation
  and high unemployment called
  stagflation
 It is difficult to envision a worse
  scenario
   the early 1970’s, spending
 In
 on the Vietnam War and social
 programs were financed with
 an increase in the money
 supply
 When  oil prices shot up from $1
 a barrel in 1970 to $35 a barrel
 in 1982, prices shot up further
 and businesses cut back
 production because resource
 prices were cutting into profits
Inflation Questions

 1. If the CPI was 100 in 1983,
 and a leather couch cost $650
 at that time, how much would
 that couch cost today with the
 CPI at 165 if the price of the
 couch increased at the same
 rate as the inflation rate?
 2.If the CPI was 155.2 in 1995
 and 149.9 in 1994, what was
 the rate of inflation (in
 percentage terms) for 1994-
 1995?
 3. If inflation is so bad, list four
 of the negative impacts

				
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posted:6/10/2011
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