Inflation

February 6 2017

Inflation

• Inflation is a general rise in price level
• It reduces the purchasing power of money
• Purchasing power is the amount of goods and services that money buys
• Ex: it takes two dollars to buy today what one dollar buy in 1982
• The ideal inflation rate is 2 - 3%

3 causes of Inflation

1. Printing too much money
2. Demand- pull inflation (demand pulls up prices)

• Demand increases but supply stays the same. The result is a shortage driving prices up.

3. Cost-push inflation

• Higher production costs increases prices

Inflation formula = current year price index - base year price index / base year price index x 100

Deflation: decline in general price level

• Disinflation occurs when inflation rate itself the declines
• The rule of 70 is used to calculate the number of years it will take for the price level to double at any given rate of inflation.
• Formula = 70 / annual rate of inflation

• Real interest rate: amount of money borrowed. % increase in purchasing power. (adjusted for inflation)
• Formula:  nominal interest rate - expected inflation
• Nominal interest rate: percent increase in money that borrowers pay back to the lender (not adjusting for inflation)

Hurt about inflation

• Lenders - people who loan out money at fixed interest rates
• Savers
• People with fixed incomes

Helped by Inflation

• Borrowers - people borrow money
• A business where the price of the product increases faster than the price of resources