AP Macroeconomics

Intro to inflation

Words of Wisdom on Inflation…

“Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man. “ Ronald Reagan

“By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”John Maynard Keynes

Does de(or in-)flation make us better or worse off? Not

necessarily…As price$ go down, $o too

($hould) incomeThat is, REAL WAGE – the

wage rate/the price level – stays the same as prices fall.

The rise in prices over the years has not made us poorer because REAL INCOME – income/the price level – has not been affected by the rise in overall prices

So what?

The level of price$ is not what matters…

What matters is the RATE (%) OF CHANGE of price$$$$$$$!

inflationDefined: The percent increase in the overall level of

prices per year (i.e. an overall increase in the price of goods)

Calculated:

Price level in year 2 – Price level in year 1 x 100 =

Inflation ratePrice level in year 1

Notice…

We measure price level along the left vertical axis (dependent), and year along the right horizontal axis (independent)

“Shoe-leather” costs?Ever withdrawn $ from the

bank multiple times in a day, or got a really big paycheck and went from store to store to store to buy certain things?

The increased costs of transactions is aka “Shoe-leather costs” (an allusion to the wear & tear caused by extra trips made to the bank to take out money for transactions)

Inflation…“Discourages people from holding onto cash because the purchasing power of the cash in your wallet and money in the bank steadily erodes as the overall level of prices rise” (Krugman, 136)

And the winner is… Inflation can produce winners &

losers in an economy

So who wins and who loses?

Usually, a lender will lose. That is, those who lent the loans in years past now find that their return is less. The repayment is worth less.

Then who will win?

But the consumer’s purchasing power is dramatically affected, as their money doesn’t go nearly as far…

Nominal vs. Real…interest rates, that is.

Just like GDP…

Nominal Interest Rate: the interest rate that is actually paid for a loan, unadjusted for the effects of inflation

Real Interest Rate: the nominal interest rate adjusted for inflation (subtract the inflation rate from the nominal interest rate)Example: The loan nominal interest rate is 10%,

and the inflation rate is 6%, then 10%-6%= 4% real interest rate

A bit o’logic for ya…If a borrower takes out a loan at a certain nominal interest rate, and the actual inflation rate is higher than expected, then the borrower will gain (winner!) because she will ultimately be paying less than anticipated.

So what do we do?

The only solution to inflation

is disinflation… which is tough. usually requires a severe recession…

And now…some resources…

Inflation calculator…

http://www.econedlink.org/interactives/index.php?iid=205&type=educator

Inflation vs. Price Index…

http://www.reffonomics.com/TRB/chapter20/inflationembedded.swf

Works CitedEconedlink. “Inflation Calculator.”

http://www.econedlink.org/interactives/index.php?iid=205&type=educator

The Economics of Seinfeld. http://yadayadayadaecon.com/clip/

Krugman, Paul, and Robin Wells. Krugman’s Economics for AP. New York, Worth Publishers.

Reffonomics. www.reffonomics.com.