notes
inflation - it represents an increase in average prices of goods and services in an economy. It reduces the purchasing power of the consumers as several items experience price increase. e
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Inflation rate- it measures the percentage increase in a price index over time. for example using consumer price index, ‘CPI’ if the base years index is 100 and the current years index is 103, then the inflation rate is simply the percentage change in the two indices which is 3%.
Deflation- it represents a decrease in the average prices of goods and services in an economy over time. it is associated with weak economic conditions as it hurts the producers.
Disinflation- it is a decrease in the rate of inflation. for example if the inflation rate was 10% last year and is 5% this year then the prices are still rising but at a slower rate.
Hyperinflation- it is an out of control inflationary spiral. For example, zimbabwe experienced prices doubling up by the minute and by the hour so that its people abandoned the usage of its local currency and started using the US dollar or the south african rands.
Stagflation- it is when prices rise in a slower economy when unemployment levels are rising
Asset price inflation- it represents prices of assets going up when there may not be a general rising trend in prices.
Dual mandate- these are the two goals of policy by the central bank.
First goal: price stability- an inflation target of 2 percent insures that the economy is growing while the prices are rising at a slow to moderate pace.
Second goal: full employment output- it is the max possible output that an economy can produce if it uses all available resources in an efficient manner.
Causes of inflation
demand push Is it when prices rise because excessive demand creates a shortage
Cost push inflation- it is when prices rise because of rising cost of production.
negative supply shock - if there isn’t enough supply, prices of that good will go up
This is when the supply curve shifts to the left and results in higher prices
Inflation Expectations- this is when prices rise because everyone expects them to rise. For example, if people expect prices to rise, they go to make the purchase right away, causing an increase in demand and thereby in prices.
Policy in change
If there’s a change in policy, by the federal government or the central bank that aims to increase consumers spending and domestic demand then prices can rise
Increase in wages
If wages rise then the costs of production will rise and so the prices will rise
Increased cost of living
If prices rise the real value of money declines so that there is an increase in the cost of living particularly if wages don’t keep up with the price increases
Contractionary policy
If inflation because a concern then a contractionary fiscal policy or a contractionary monetary policy may be needed to tap on the breaks for the economy
wage price spiral
if prices rise then so must the wages, if wages rise then so must the prices
Consumer price index (CPI)
it measures price variation of a certain market basket of goods and services purchased by a typical urban consumer.
some criticisms of using CPI are
it does not account for changes in technology
it does not account for changes made to a cheap substitute
it does not talk about changes in prices phased in non urban consumers
Producers price index (PPI)
it looks at price variations of products sold by domestic producers
GDP Deflator
It looks at price variations based off nominal GDP and real GDP
expenditures price index
it looks at price variations of items bought by a domestic consumer. it is the favorite method
expansionary fiscal policy - it is expanded by the government during a recession by increasing government spending and or reducing taxes to stimulate demand and spending. the increase in aggregate demand will shift the AD curve to the right up until the output produced is equal to the potential output and the economy returns to an equilibrium along the vertical LRAS curve. however due to policy lags in implementation and the results if the ADR curve does not shift by the target amount then more steps may be needed to get the correct magnitude of the AD shift for instance if the AD shift is smaller than needed a further boost to AD may be needed or else if the AD shift is more than that needed then a corrective opposite policy which is contractionary may be needed.