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    PPT - Inflation

    • Inflation is the persistent and appreciable rise in the general or average level of prices over time
      • Measured by the Consumer Price Index - a weighted index based on proportion of income spent on a particular group of items
      • Measures changes in the price of a basket of goods and services bought by households from 1 quarter to the next
    • CPI
      • Attaches weights to each commodity to reflect importance in pattern of expenditure in an average household
      • Weights change depending on preference or reaction to changes in price
      • Rate: $\frac{[CPI(Y2)-CPI(Y1)]}{CPI(Y1)}\times100$
    • Headline vs Underlying
      • Headline measure (CPI): the measure that is reported by the media
      • Underlying measure: inflation that best reflects market forces
        • Trimmed Mean: remove the most volatile 15% of items from each side of the CPI
        • Weighted median: change in middle 50th percentile by weight
        • CPI excluding volatile items: Average inflation rate of all items in the CPI basket except for fruits, vegetables or fuels (these are very volatile items)
          • Will always remove the same, volatile elements
    • Limitations of CPI
      • Only reports price movements in metro areas
      • Does not account for quality of goods and services - only price
      • Not regarded as "true" cost of living index: does not reflect changing consumer preferences or substitutes that consumers make daily
    • Types of inflation
      • Demand-pull inflation: Excess of aggregate demand over aggregate supply at the full employment level of output, and is caused by an increase in aggregate demand
        • Rise in the general price level resulting from an excess of demand over supply
        • "too much money chasing too few goods"
        • Will also push wage prices up with higher demand
      • Cost push inflation: Caused by a fall in aggregate supply, in turn resulting from increase in wages or prices of other inputs
        • Rise in production costs are passed on to consumers who have to pay higher prices for final goods and service

    Inflation Questions

    1. Why is cost-push inflation potentially more serious than demand-pull?
      • Cost push is caused by suppliers, who pass costs on to consumers. On the other hand demand-pull is a more theoretical concept, and demand is often much easier to correct than supply shock, where overcoming some scenarios is harder.
    2. Explain whether each scenario is CP or DP inflation.
      • Demand-pull
      • Demand-pull
      • Cost-push

    Costs of Inflation

    • Reduces Real Income (purchasing power)
      • Buy less goods with same money
    • Affects Interest Rates
      • Real $IR$ (nominal $IR$-inflation) must be positive for lenders to make profit and lend
    • International Competitiveness
      • Country's exports at disadvantage when domestic inflation is greater than o/s (overseas)
    • Currency depreciation
      • Less o/s demand for country's goods
    • Capital for labour substitution
      • Due to wage inflation and structural change
    • Uncertainty for decision makers
      • Investment decisions, reduce output and employment opportunities
    • Economic Efficiency
      • People move away form productive to speculative activities (assets, investment): negative impact on economic output
    • Hyperinflation
      • Above $30% p.a. \rightarrow$ diversion of efforts towards hoarding or non-productive activities
    • Reduction in income equality
      • Bracket creeps: As income rises with inflation, higher margin of tax leading to fewer tax brackets

    Benefits

    • it encourages borrowing and consumption
    • Helps to maintain low interest rates
      • Support economic confidence
      • Encourages higher levels of consumption and investment
    • Creates confidence about growth of economy
      • Assets like houses will increase in value over time
      • Changes in prices are predictable, allowing consumers/producers to comfortably make long term decisions

    Questions

    1. Inflation is the persistent and appreciable rise in the general or average level of prices over time
    2. $2-3%$
    3. The consumer price index measures changes in the price of a basket of goods and services bought by the average household from 1 quarter to the next through the proportion of income spent on a particular group of items
    4. Different commodities may have different weights, so accounting for these we should have one measure
    5. Food and N-alc beverages, Alcohol and tobacco, clothing and footwear, housing, furnishings, household equipment and services, health, transport, communication, recreation and culture, education, insurance and finance services
    6. $104.7\rightarrow 107=2.2%$
    7. Underlying measure can trim the sides, use a weighted median or exclude volatile items - all of which exclude some prices
    8. An economy that is growing fast will increase Aggregate Demand, leading to demand-pull inflation
    9. Cost-push inflation is caused by a fall in aggregate supply resulting from increase in wages or prices of other inputs
    10. cost-push (oil prices)
    11. It reduces inflation as AD and supply decrease.
    12. Workers now demand increases in wages in anticipation of higher future inflation and as the cost of their labour increases, some businesses will reduce the number of people they employ
    13. Inflation reduces income inequality through tax bracket creeps
    14. Country's exports at disadvantage when domestic inflation is greater than o/s (overseas)
    15. Damn bro

    True/False

    1. T
    2. T
    3. T
    4. F
    5. F
    6. T
    7. T
    8. T
    9. T
    10. F
    11. T
    12. F
    13. T
    14. T