Inflation: general rise in price level. Annual rate of change.
How to measure inflation rate:
1. compare price level of current year to past year (base year)
2. find % of change
Causes of inflation
1. Demand (pull)
a. everyone tries to buy more than economy can produce
b. law of supply and demand: if demand increases
too fast, prices are "pulled" up
2. Monetary factors
a. when the Federal Reserve (FED) lowers interest
rates too much, the money supply increases too fast
b. people demand more goods than businesses can
produce
c. "too much money chasing too few goods"
3. Cost (push)
a. cost of resources (inputs) helps determine price
b. increased costs of inputs "pushes" the price
of goods up
Consequences of inflation
1. Each dollar buys less
a. 1982 dollar was worth about 75 cents in 2000
b. this is especially hard on people on fixed incomes
c. less difficult for professionals - doctors and
lawyers - they can simply increase their fees to keep up with inflation
2. Spending habits change
a. interest rates usually increase
to fight inflation = it becomes harder to borrow money, therefore spending
(demand) slows down
3. Distribution of income is altered
a. lenders are hurt more than borrowers
1. people repay loans in
devalued dollars
2. savings don't yield (earn)
as much if inflation is higher than interest earnings
Deflation: decrease in general price levels
1. only 2 significant deflation periods in nation's history
a. post WWI recession of 1920s
b. Great Depression of 1930s