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Understanding Inflation and Deflation

This document discusses inflation and deflation. It defines inflation as a rise in the general price level as measured by the consumer price index (CPI), while deflation is a fall in the general price level. Inflation can be caused by an increase in aggregate demand or a decrease in aggregate supply, while deflation can result from a decrease in aggregate demand or an increase in aggregate supply. The quantity theory of money holds that if the money supply increases while the velocity of money and output remain constant, prices will rise. Low unemployment is often associated with higher inflation as more money is being spent. The goals of monetary policy are price stability and low unemployment.

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672 views18 pages

Understanding Inflation and Deflation

This document discusses inflation and deflation. It defines inflation as a rise in the general price level as measured by the consumer price index (CPI), while deflation is a fall in the general price level. Inflation can be caused by an increase in aggregate demand or a decrease in aggregate supply, while deflation can result from a decrease in aggregate demand or an increase in aggregate supply. The quantity theory of money holds that if the money supply increases while the velocity of money and output remain constant, prices will rise. Low unemployment is often associated with higher inflation as more money is being spent. The goals of monetary policy are price stability and low unemployment.

Uploaded by

Steeeeeeeeph
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd

Inflation & Deflation

Reference 13.1 and 13.2

Aggregate=all together
Aggregate demand and aggregate supply
considers the entire quantity of goods and
services in an economy.
The equilibrium price in aggregate supply
and demand curves is called the price level.
S1

D1

Inflation / Deflation
What is it?
an increase in the price level
a decrease in price level
CPI= Consumer Price Index
How is it determined?
by comparing the CPI in different years and
noting the change
CPI is higher=inflation
CPI is lower=deflation

Last years CPI (based on 1984 prices)


$216.17
This years CPI
$218.70
Inflation rate
3.82%

Can be caused by
supply-side shifts or demand-side shifts
woohoo!!
more people!!
more money!!

Under what conditions would you expect


to see inflation (rise in price level)?
Inflation can be caused by an increase in aggregate demand
Inflation can be caused by a decrease in aggregate supply

o
gr il
ain

Under what conditions would you expect


to see deflation (fall in price level)?
Deflation can be caused by a decrease in aggregate demand
Deflation can be caused by an increase in aggregate supply

Simple Quantity Theory of Money


If velocity and quantity of output (supply)
are constant, more money in circulation
leads to higher prices.
What does velocity mean?

velocity=the average number of times per year


a dollar is spent to buy final goods

Simple Quantity Theory of Money


If velocity and quantity of output (supply)
are constant, more money in circulation
leads to higher prices.
MxV=PxQ
M = money supply
V = velocity
P = price level
Q = quantity of output

% change M = % change P

Inflation Rates between 1952 and


2008

Low levels of unemployment are


frequently periods of higher inflation

More working people


with
more money
(increase in aggregate demand)

remember

Monetary Policy?

The goal is to maintain price stability and


low unemployment.

Monetary Policy
Fed is responsible for maintaining price
stability and employment
Expansionary Monetary Policy
goal is to increase money supply
to reduce unemployment
to avoid deflation

Contractionary Monetary Policy


goal is to decrease the money supply
to reduce inflation

So What?
Negative Effects of Inflation
hurts people on fixed incomes (the retired)
hurts savers
hurts lenders (helps debtors)
hurts people who contract to be paid in the future
makes financial decision making more difficult
hedging = avoiding or lessening a loss by taking a
counterbalancing action.
buy gold or some other store of value besides money

So What?
Negative Effects of Deflation
Great Depression!
uneven fall in prices
business failures
job loss

hurts debtors
hurts property-owners

Stagflation
Whats up with that?

stagnant (persistently high) unemployment

and
inflation
1970s US and other industrialized nations experienced stagflation
erratic monetary policy: stop-and-go, on-and-off
supply shocks (OPEC)

Review
What are some possible causes of
inflation?
What are some possible causes of
deflation?
Why is the relationship between
unemployment and inflation usually
inverse?
Why is inflation a problem?

Review
How does the the fed use monetary
policy to control inflation?

Homework
Read Chapter 14 Business Cycles and
Economic Growth pps. 364-386
Complete Review Sections p.386-387
Economics Vocabulary (writing complete sentences)
Review Questions
Analyzing Primary Sources

Be prepared to take a chapter quiz

Todays Exit Pass


In a small group, read 13.3
Unemployment
Section Review p. 359
#1 Definitions
#2-3 (complete sentences)

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