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Chapter 7 - Inflation and the measurement of prices. After completing this unit, you should be able to: Explain the difference between the face value of money and the purchasing power of money, describe inflation and calculate inflation across time periods, describe the winners and losers from inflation,…
Introduction to Economics: Social Issues and Economic Thinking Wendy A Stock Chapter Inflation and the Measurement of Prices Copyright © 2013 John Wiley & Sons, Inc / Photo Credit: public domain image from wikipedia: http:en.wikipedia.org/wiki/File: Mugabecloseup20008.jpg PowerPoint Prepared by Z Pan After studying this chapter, you should be able to: Ø Ø Ø Explain the difference between the face value of money and the purchasing power of money Describe inflation and calculate inflation across time periods Ø Ø Distinguish the sources of inflation Illustrate the difference between real and nominal values Describe the winners and losers from inflation Copyright © 2013 John Wiley & Sons, Inc Inflation Ø Ø Inflation is the rise in the general level of prices in an economy Zimbabwe’s hyperinflation Ø Inflation rate 11.2 million percent per year Ø prices doubled every 25 hours! Copyright © 2013 John Wiley THE VALUE AND USES OF MONEY Ø Ø The Face Value of Money is determined by governments and printed on currency The Purchasing Power of Money reflects the amount of goods and services that a given unit of money could be used to acquire Copyright © 2013 John Wiley Definition of Money Three Roles of Money: Ø Ø Ø Medium of Exchange – Money can be used as a means of payment for goods and services or repayment of debt Unit of Account – Money provides a common measure of the worth of goods or services Store of Value – Money can be saved and used to purchase goods and services at a future time Copyright © 2013 John Wiley Evolution of money Ø Commodity Money has value for its own sake, in addition to its value as money Ø Ø e.g gold, silver, shells, stones, decorated belts, cigarettes, and alcohol Fiat Money has value because of government law or regulation Ø e.g Federal Reserve Notes, most paper money Copyright © 2013 John Wiley MEASURING PRICES AND INFLATION Ø Ø Ø Price Index - A measure of the average prices of a given set of goods or services across time Consumer Price Index (CPI) is the ratio of the cost of the market basket in one year over the cost of the market basket in the base year multiplied by 100 A Market Basket is a fixed set of goods or services whose prices are tracked across time Copyright © 2013 John Wiley MEASURING PRICES AND INFLATION Copyright © 2013 John Wiley Calculating cpi: an example Three Steps: 1) 2) 3) Finding the prices in the market basket Computing the cost of the market basket in each year Calculating CPI by taking the ratio Copyright © 2013 John Wiley Calculating cpi: an example Copyright © 2013 John Wiley 10 U.S Consumer price index Copyright © 2013 John Wiley 11 Inflation rate Copyright © 2013 John Wiley 12 Calculating inflation rate – an example Copyright © 2013 John Wiley 13 U.S inflation rate (1950-2010) Copyright © 2013 John Wiley 14 Deflation and Disinflation Disinflation is a period of positive but falling inflation Disinflation indicates a slowing of the rate of price increase in the economy Deflation is negative inflation Deflation indicates a period of declining prices of goods and services Copyright © 2013 John Wiley 15 World inflation comparison Copyright © 2013 John Wiley 16 Sources of INFLATION Ø Government printing too much money Ø Demand Pull Inflation Ø Cost Push Inflation Copyright © 2013 John Wiley 17 Sources of INFLATION Demand-pull Inflation arises from increases in aggregate demand Copyright © 2013 John Wiley 18 Sources of INFLATION Cost-push Inflation arises from decreases in aggregate supply Copyright © 2013 John Wiley 19 MEASURING NOMINAL AND REAL VALUES Ø Ø Nominal Values are values that have not been adjusted for inflation Real Values are values that have been adjusted for inflation Copyright © 2013 John Wiley 20 MEASURING NOMINAL AND REAL VALUES An Example: 1960: CPI = 29.6 Your grandma's starting salary as a school teacher = $6,500 2010: CPI = 220.2 Your starting salary as a school teacher = $45,000 Will you make more than she did in real earnings? Copyright © 2013 John Wiley 21 MEASURING NOMINAL AND REAL VALUES Ø First, convert all nominal values into real values in base year (base year = 1982 – 84) Real value in base year = (nominal value in current year/CPI in current year) x 100 Ø Then, compare Copyright © 2013 John Wiley 22 MEASURING NOMINAL AND REAL VALUES 1960: CPI = 29.6 Your grandma's starting salary as school teacher = $6,500 2010: CPI = 220.2 Your starting salary as a school teacher = $45,000 Grandma’s real salary = ($6,500/29.6) x 100 = $21,959 in 1982–84 dollars Your real salary = ($45,000/220.2) x 100 = $20,436 in 1982–84 dollars Copyright © 2013 John Wiley 23 Questions/Discussions During 2011, many citizens in the Middle East called for governmental reform In some countries, oil production was reduced in the face of protests Use an AD/AS diagram to illustrate the potential impact of these outcomes on inflation in the United States Copyright © 2013 John Wiley 24 Key Concepts • • • • • • • • • • Inflation Face value of money Purchasing power of money Medium of exchange Unit of account Store of value Commodity money Fiat money Price index Market basket Copyright © 2013 John Wiley 25 ... Copyright © 2013 John Wiley 17 Sources of INFLATION Demand-pull Inflation arises from increases in aggregate demand Copyright © 2013 John Wiley 18 Sources of INFLATION Cost-push Inflation arises from... Money provides a common measure of the worth of goods or services Store of Value – Money can be saved and used to purchase goods and services at a future time Copyright © 2013 John Wiley Evolution...After studying this chapter, you should be able to: Ø Ø Ø Explain the difference between the face value of money and the purchasing power of money Describe inflation and calculate inflation