Chapter 26: Inflation

Inflation

General and continuing rise in prices measured as a rate.

Deflation

A fall in prices or an economic slowdown.

Aggregate demand

Total demand in the economy from consumers, businesses, government, and foreign buyers.

CPI (Consumer Price Index)

A measure of the general price level.

Demand pull inflation

Inflation caused by an increase in demand in the economy.

Cost pull inflation

Inflation caused by rising business costs.

Interest rates

Price paid to lenders for borrowed money.

Monetarists

Economists who believe there is a strong link between growth in the money supply and inflation.

Money supply

The stock of notes and coins, bank deposits, and other financial assets in the economy.

Menu costs

The non-monetary costs incurred by firms due to frequently changing prices.

Shoe leather costs

The non-monetary costs for individuals and businesses of shopping around to find the best prices.

Hyperinflation

A situation where prices spiral out of control, leading consumers to rush to buy before prices increase further.

Tradeoff between inflation and unemployment

The relationship where rising inflation can reduce unemployment, but may lead to higher costs.

Wage/price spiral

A cycle where rising wages lead to higher production costs, subsequently driving up prices.

Impacts of Inflation

Includes rising prices, increased wage demands, difficulties in exporting, and potential job losses.

Impact of Inflation on Prices

Inflation leads to a general increase in prices for goods and services, eroding consumers' purchasing power.

Impact of Inflation on Wages

Workers often demand higher wages to keep up with inflation, resulting in increased labor costs for businesses.

Impact of Inflation on Exports

Rising domestic prices can decrease competitiveness of exports, as foreign buyers find domestic goods more expensive.

Impact of Inflation on Unemployment

Inflation can lead to higher unemployment if companies cut jobs to manage increased costs associated with rising prices.

Impact of Inflation on Menu Costs

Businesses incur menu costs by frequently changing prices, which can be expensive and time-consuming.

Impact of Inflation on Shoe Leather Costs

Individuals and businesses may spend more time searching for the best prices, leading to non-monetary costs associated with the effort.

Impact of Inflation on Uncertainty

Inflation creates uncertainty in the economy, making it difficult for businesses to plan for the future effectively.

Impact of Inflation on Business & Consumer Confidence

High inflation can reduce confidence among consumers and businesses, leading to decreased spending and investment.

Impact of Inflation on Investment

Uncertainty around inflation can deter investment, as businesses may hesitate to commit resources in

Why is CPI used?

CPI is used as an economic indicator to gauge inflation, cost of living adjustments, and to inform monetary policy.

Possible causes of increased aggregate demand

Factors include increased consumer spending, government expenditure, business investments, and net exports.

Possible causes of rising business costs

Causes can include increased raw material prices, higher labor costs, and regulatory costs.

Key concept of monetarists

Monetarists believe that the money supply is the primary driver of economic activity and inflation, emphasizing the control of money supply to manage inflation.

How can interest rates be used to lower inflation (chain of reasoning)

1. Higher interest rates reduce borrowing because the “price of money” increases

2. Money supply therefore grows less quickly

3. Demand will therefore fall

4. Pressure on prices is therefore relieved

5. Inflation falls