EC102 Week6 Money

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    Inflation ()

    Inflation: measured in terms of changesin price index, spec the CPI

    How do we compute inflation rate?How do we compute inflation rate?How do we compute inflation rate?How do we compute inflation rate?

    Thru the CPI:

    Two types of inflation (based on timeframe)

    Short Term InflationShort Term InflationShort Term InflationShort Term Inflation

    Increase in nominal MS

    Increase in G,C, and I

    Response to supply shocks (changes inprices of raw materials, changes in workerswage demands) Ex: Oil

    Long Term InflationLong Term InflationLong Term InflationLong Term Inflation

    Sustained rapid growth in MS

    Costs of Inflation

    Concern of households, business firms andConcern of households, business firms andConcern of households, business firms andConcern of households, business firms andpolicy makers implies that there are costs topolicy makers implies that there are costs topolicy makers implies that there are costs topolicy makers implies that there are costs tothe economy because of inflationthe economy because of inflationthe economy because of inflationthe economy because of inflation

    Two Kinds: Expected and Unexpected InflationTwo Kinds: Expected and Unexpected InflationTwo Kinds: Expected and Unexpected InflationTwo Kinds: Expected and Unexpected Inflation

    Expected Inflation

    Inflation that is anticipated Example: If you hold PhP100 of currency in 2006

    when inflation rate is 9%, you lost PhP9 of purchasingpower over the year

    Costs of Expected Inflation Shoe leather CostShoe leather CostShoe leather CostShoe leather Cost

    Cost to households and business firms ofmaking more trips to the banks to avoidholding significant amount of pesos orshifting funds from interest bearing assets

    to money. Bracket CreepBracket CreepBracket CreepBracket Creep

    Tax rate is defined in nominal terms, andindividual income tax is progressive andfully indexed against inflation

    Example: Inflation also increases in wage,thus higher tax rates and higher prices

    Who benefits? Corporations and lenders do.

    Menu CostMenu CostMenu CostMenu Cost

    Cost to firms because of changing prices(reprinting price list, informing customers0

    Prices are not synchronized in the whole

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