Ch. 14: InflationCh. 14: InflationCIE3M1-01

What Is Inflation?What Is Inflation?Inflation is the increase in the

prices of goods & services over a period of time

Figure 14.1 pg. 290 comments?

How To Increase Your How To Increase Your Income Without Doing More Income Without Doing More WorkWorkCost of living allowances can be

calculated in the following manner: (Costs Today / Past Costs) x 100%

Gas = $1.25 / $0.50 x 100% = 250%

The Consumer Price IndexThe Consumer Price IndexCPI 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)

The Consumer Price IndexThe Consumer Price IndexCurrent 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 1940Inflation Since 19401940 – 42 prices rose rapidly

because of WW 21943 – 45 government controlled

prices1946 – 49 rapid price increase

with end of war1951 Korean War drove up prices

Inflation Since 1940Inflation Since 1940

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%)6. Figure 14.5 pg. 293 #1 - 3

Inflation: The Winner & Inflation: The Winner & LosersLosersThose who owe money

(borrowers) win and those who are owed money (lenders) 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: The Winner & Inflation: The Winner & LosersLosersInflation shifts benefits from

creditors to debtorsHyperinflation 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)

Inflation: The Winner & Inflation: The Winner & LosersLosersDeflation – decrease in the

general level of prices over time (Depression 1930s)

Pgs. 301 – 302 #1 - 2

What Causes Inflation?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

What Causes Inflation?What Causes Inflation?

Demand-Pull InflationDemand-Pull InflationIf 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

Demand-Pull InflationDemand-Pull Inflation

Government Policies to Government Policies to Control Demand-Pull InflationControl Demand-Pull Inflation1. Contractionary Fiscal Policy – G

↓ and T ↑ ↑ gov’t revenue for use during a recession

2. Contractionary / Tight Money Policy – Sell bonds, ↑ the bank rate and use moral suasion to discourage bank loans

3. Pg. 303 #3 - 5

Applying Fiscal & Monetary Applying Fiscal & Monetary Policy To Demand-Pull Policy To Demand-Pull InflationInflation1. 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’ Cost-Push / Sellers’ InflationInflationresource costs (e.g. ,wages)

increase producers pass on the increased costs to consumers in the form of higher priced products

The worst situation is the twin evils of inflation & unemployment existing at the same time stagflation

Cost-Push / Sellers’ Cost-Push / Sellers’ InflationInflationStagflation - occurred in the

1970s when OPEC raised the price of oil which was an essential source of energy for the Canadian economy (e.g. bucket has holes on the side that leak)

Cost-Push / Sellers’ Cost-Push / Sellers’ InflationInflation

Income vs. Expenditure Income vs. Expenditure Method Of Measuring The Method Of Measuring The EconomyEconomyC + I + G + (X – M) = GDP

Expenditure MethodM (supply of money) x V (velocity

of circulation of money) = GDPGDP = P x Q MV = PQRecession – M ↑ x V = P x Q↑Full Employment – M ↑ x V = P ↑

x Q

Income vs. Expenditure Income vs. Expenditure Method Of Measuring The Method Of Measuring The EconomyEconomyMonetary 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

∆% GDP ↑ = ∆% M ↑

Income vs. Expenditure Income vs. Expenditure Method Of Measuring The Method Of Measuring The EconomyEconomyKeynesians believe in using G

and T to solve the problems of the economy

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 & Price ControlsWage & Price ControlsPolicies 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.

Wage & Price ControlsWage & Price Controls

1. lack of united support2. large bureaucracy needed3. interference with the operation

of the market 4. import prices all contributed to the lack of

success