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Economics Chapter 13 Inflation
Terms in this set (26)
term economists use to describe a sustained rise in the average price level
When inflation occurs, do all goods and services rise in price?
no - this is why they refer to the average price level - NOT all goods and services will increase in price
Do all prices increase by the same amount?
Again - this is why it is called the average price level because not all prices increase by the same amount
inflation - is it a bad thing?
this increase in the overall average level of prices in the economy is considered negative or bad by many - Inflation's effects on an economy are various and can be simultaneously positive and negative; it does hurt those living on a fixed income such as the elderly; NEGATIVE: Negative effects include an increase in the opportunity cost of holding money, uncertainty over future inflation which may discourage investment and savings, and if inflation were rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future. POSITIVE: Positive effects include ensuring that central banks can adjust real interest rates and encouraging investment in non-monetary capital projects
How does inflation hurt the elderly?
many older citizens live on fixed retirement pensions that were granted before payments were automatically adjusted to take in account inflation. This makes it increasingly difficult for the elderly to survive year after year because as prices continue to rise, their dollars purchase fewer and fewer goods forcing the elderly to dig into their savings
What have many employers begun doing to take into consideration future inflation?
employers are taking future inflation into consideration when developing their pension plans agreeing to make cost of living adjustments (COLAs); these adjust payments upward as inflation causes prices to rise
Cost of living adjustments (COLAs)
An automatic raise in pension payments to compensate for inflation; compensates for the fact that basic living costs vary greatly around the world and even in one place as inflation rises; An automatic increase in the incomes (wages) of workers when inflation occurs; guaranteed by a collective bargaining contract between firms and workers.
What other groups are hurt by inflation?
creditors, savers, and consumers
How are creditors hurt by inflation?
they only receive a fixed amount back even though their costs might rise due to inflation (once the money borrowed is returned or repaid); this situation obviously discourages lending; when the situation is extreme enough, it could even cause a complete collapse of credit markets - ALL lending institutions will STOP lending
What are the heart of the economy?
financial institutions such as lending agencies because they get capital to businesses to enable them to improve their infrastructure
How do many lenders try and alleviate the problems associated with inflation?
by tying the interest rate of the loan to the inflation rate in the contract of the loan; the way this works - as general price levels rise, so do the amounts for loan payments
How are savers hurt by inflation?
if prices increase faster than the rate one is being paid for his or her investments, then it DOES NOT make any sense to save money
Is it better to spend now rather than save money when inflation is high?
not necessarily - only when inflation rates are extremely high; during normal times of inflation - one can typically get rates that beat inflation or no one would ever save; REMEMBER - the higher inflation is, the less profitable it is to save
What occurs when some have developed a pathological fear of lost savings due to inflation?
less money is available to loan to businesses to put into their infrastructure - thus businesses have an over-taxed infrastructure
How are consumers hurt by inflation?
when a consumer's wages DON'T rise as quickly as prices (due to inflation), then those wages can't buy as much as they used to; purchasing power is lost
Inflation: winners vs. losers
LOSER: fixed income pensioner - as prices rise they experience a loss in buying power VS.
WINNER: pension fund - during these times, the fund experiences a gain in buying power
LOSER: creditors/lenders - income is fixed and yet the loan payments do not take into account that prices have risen due to inflation
WINNER: borrowers - salaries tend to increase with inflation - to help meet inflations rates, but the loan payments (car loan or house loan - even a student loan) is fixed
LOSERS: savers - savers receive a low return on savings accounts as growing inflation makes the cost of prices rise
WINNERS: financial institutions/lenders - investments such as buying stock is profitable for these companies while there is still a low interest rate on savings accounts
When a country experiences exorbitant inflation, why is it safe to say there are NO WINNERS?
there is a loss of confidence in the entire system; everyone is afraid to save because they fear they will just lose out; if no one saves, then there is NO investments; work ethics are ignored - it is difficult to have a good work ethic when you work - WHY work when your wages will be worthless in 2 days; this causes every aspect of an economy to shrivel in the face of an uncertain future
What are some reasons for Cost of living adjustments (COLAs)?
help compensate for inflation; act as a disability insurance provision to increase monthly benefits; compensates for the fact that basic living costs vary greatly around the world; provides an automatic increase in the incomes (wages) of workers when inflation occurs; guaranteed by a collective bargaining contract between firms and workers
causes of inflation
1. Increase in money supply
2. demand pull - all sectors try to buy more than the economy can produce
3. deficit spending
4. wage push
5. cost push - rise in prices due to an increase in the cost of the factors of production
6. spiral of wages and prices - caused by mutually reinforcing changes in aggregate supply and aggregate demand
7. excessive monetary growth
8. demand for goods/services rise so much, there's a shortage, therefore prices rise
9. population increases cause prices to increase
10. war causes increase in the price in raw materials, expenses or salaries; too much money circulating the economy
1. Government intervention can serve to stabilize the macro-economy
2. wage price controls
3. commanded cheapness
4. limitation of money creation
consumer price index (CPI)
A measure of the overall cost of the goods and services bought by a typical consumer; Shows changes in the average prices of goods and services purchased by consumers over a period of time
Period of time that usually covers 12 months: and is divided in to four consecutive quarters., A period that is used for comparison in financial statements analysis., A time period used as a reference for creating a price index.
An upward revision of the tax brackets to keep workers from paying higher taxes just because of inflation., Avoiding generalizations by acknowledging the time frame in which we judge others and ourselves, Providing automatic increases to compensate for inflation.
cost push inflation
increases in the price level (inflation)resulting from an increase in resource costs (for example, raw material prices) and hence in per unit production costs; inflation caused by reductions in aggregate supply, A rise in prices due to an increase in the cost of the factors of production.
demand pull inflation
Inflation resulting from an increase in aggregate demand. Increases in the following factors: money supply, government purchases, and price level in the rest of the world can impact this., Inflation caused primarily by excess aggregate demand. Consumer driven inflation - consumers are trying to spend more economy can produce.
A very rapid rise in the price level; an extremely high rate of inflation (Example - When the German economy tried to print bills to pay off their debt, inflation rates of 40% a day in 1923, A period of very rapid increases in the overall price level, An extreme form of inflation where the value of the money decreases an excessive amount over a short period of time. Happened in Germany following World War I, where money became almost worthless and prizes doubled every two day. In 1922 a loaf of bread cost 163 German marks, in late 1923 it would cost 200,000,000,000 marks;, A rate of inflation so high that the value of money becomes close to worthless.
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