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IV. Inflation
A. An increase in prices is measured by a price index
such as the consumer producer
index, CPI and the Producer Price Index,
PPI.
B. The PPI measures the change in wholesale
prices.
C. The PPI is a
leading indicator for CPI as
wholesalers can usually pass price
changes on to retailers who pass them to
consumer.
1. Recent increases in
foreign competition made passing price increases on
more difficult.
2. The internet
had the same kind of affect in the late 1990's.
 D. The inflation rate for a year when a basket
of
consumer goods increase from $400 to
$420 would be calculated as follows.
E.
Recent inflation data
provided by the Department of Labor
V. Causes of inflation
A. Demand-pull inflation
1. Increases in C + I + G + XN will cause GDP to increase.
2. As the economy nears full employment, the prosperity caused by high
employment
increases
demand and put upward pressure on prices.
3. When this happens, the
economy is said to be overheated.
B. Cost-push inflation
1. As the economy approaches full employment factor resources become
scarce
allowing their
owners to increase prices.
2. Supply-side shocks can cause high resource prices even if demand for
resources is low,
i.e.,
OPEC's two oil embargoes of the 1970's
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VI. Economic effect of inflation
A. Both income and resource allocations are affected by inflation
as the market tries
to adjust to the loss in value
caused by inflation.
1. High gas prices in
the 1970's caused a switch to small cars and many people
bought wood stoves.
2. Low gas prices in the
1990's made RV's less expensive to run.
B. Debtors (homeowners, businesses, government) are helped by high inflation
because they pay back with dollars worth less than those
borrowed.
C. Creditors are hurt by inflation as they are paid
back in less valuable dollars.
Those on a fixed income are also
hurt by the
cheaper dollars.
D. Cost-of-Living Increases (COLA's) were instituted in the 1970's
to
negate the severe effects of that period's high inflation.
For more
information
visit
Cost of living from
Wikipedia.
E. Deflating GDP
1. Inflation can be taken
out of growth in GDP by expressing later year
production at earlier year prices.
2. In the following
chart, letters Q, P and T are quantity, price per unit
and total respectively.
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