Download Ch. 14 Inflation

Ch. 14: Inflation
What Is Inflation?
 Inflation is the increase in the prices of goods & services over a period of time
How To Increase Your Income Without Doing More Work
 Cost of living allowances can be calculated in the following manner:
Costs Today / Past Costs x 100%
The Consumer Price Index
 CPI is a measure of the general changes in market prices of a selected group of
goods & services (< 400) purchased by the typical urban (> 30,000) family
 Products are weighted according their proportion of total household expenditures
with seven components (food 18.1, housing 36.3, clothing 8.7, transportation
18.3, health 4.2, recreation and education 8.8, tobacco / alcohol 5.6)
 Current base year 1986 given the number 100 whereas 1990 is 117, which means
there was 17 % inflation (Current Year CPI / Base Year CPI x 100%)
 CPI, GDP and unemployment rate are the three most commonly used indicators
of how the Canadian economy is doing
Inflation Since 1940
 1940 – 42 prices rose rapidly because of WW 2
 1943 – 45 government controlled prices
 1946 – 49 rapid price increase with end of war
 1951 Korean War drove up prices
1. 1953 – 65 (low inflation of 1.5%)
2. 1966 – 72 (higher inflation of 4.8%)
3. 1973 – 82 (9% inflation)
4. 1983 – 91 (< 5% inflation)
5. 1991 - (low inflation of < 2%)
Inflation: The Winners And The Losers
Those who owe money win and those who are owed money lose.
 Inflation Race – expanding businesses, workers in powerful bargaining positions,
and those who borrowed money are the winners. Declining industries, workers in
weak bargaining positions, and those on fixed incomes lose.
 Inflation shifts benefits from creditors to debtors
 Hyperinflation or extremely high rates of inflation devastates an economy causing
money to become worthless  people turn to barter destroying benefits
specialization (higher quality, cheaper products and more leisure time)
 Deflation – decrease in the general level of prices over time (Depression 1930s)
What Causes Inflation?
 Full employment and no inflation is the ideal situation (i.e. full bucket)
 Bucket shows real output which is adjusted for inflation so that different year’s
outputs can be compared
-2Demand-pull inflation
 If full employment exists (full bucket) and injections (X + I + G) > leakages M +
S + T) then no more goods & services can be produced, only prices will rise
(inflation, water spilling out of the bucket)
 Demand for goods & services > quantity of goods & services pulls up prices
Government policies to control demand-pull inflation
1. Contractionary fiscal policy – G decreases and T increases which also generates
gov’t revenue for use during a recession
2. Contractionary / Tight Money Policy – Sell bonds, increase the bank rate and use
Applying fiscal and monetary policy to demand-pull inflation
1. Unemployment – the biggest negative consequence of controlling inflation with
contractionary policies
2. Delays in applying the policy – recognition lag; decision lag; implementation lag;
Cost-push / Sellers’ Inflation
When resource costs like wages increase causing producers to pass on the increased costs
to consumers in the form of higher priced products
 The worst situation is the twin evils of inflation and unemployment existing at the
same time  stagflation – occurred in the 1970s when OPEC raised the price of
oil which was an essential source of energy of the Canadian economy (e.g. bucket
has holes on the side that leak)
Income vs. Expenditure Method of Measuring the Economy
 C + I + G + (X – M) = GDP  Expenditure Method
 M (supply of money) x V (velocity of circulation of money) = GDP
 GDP = P x Q  MV = PQ
 Recession – M(increases) x V = P x Q(increases)
 Full Employment - M(increases) x V = P(increases) x Q
 Monetary Rule – economist Milton Friedman believed that the money supply (M)
should only be increased by the same amount as the increase in the amount of
GDP which would solve the problem of inflation
 Keynesians believe in using G and T to solve the problems of the economy
whereas Monetarists believe G and T cause more problems than they solve and
the economy would be healthiest if money supply grows proportionally with GDP
Wage and Price Controls
 Policies aimed at restraining inflation by holding wages and prices below a
specific level
 Successful controls during WW 2 but unsuccessful controls in the 1960s and 70s
 Lack of united support; large bureaucracy needed; interference with the operation
of the market; and import prices all contributed to the lack of success