Inflation

Is a dollar today worth more or less than a dollar

tomorrow?

Example – Movie Box Office Top 5 grossing films of all-

time Actual receipts

1. Avatar (09) 2. Titanic (97) 3. Dark Knight (08) 4. Star Wars (77) 5. Shrek 2 (04) 6. ET (82)

Others include Pirates, recent Star Wars, Spider Man & Transformers vs Titanic, Jaws, Dr. Zhivago, Jungle Book & Snow White.

Top 5 Grossing Films of all-time

Adjusted Receipts

Gone With The Wind (39) Star Wars (77) Sound of Music (65) ET (82) 10 Commandments (56)

Aggregates

Aggregate = The total market

Aggregate Demand Total amount of goods & services

demanded. Aggregate Supply

Total amount of goods & services supplied.

Price levels Given aggregate supply & demand,

there is a price level for an economy.

Inflation price levels increase Aggregate demand > aggregate supply

Deflation Price levels decrease Aggregate demand < aggregate supply

Causes of Inflation

2 types Demand-pull inflation

Aggregate demand > productive capacity Causes include increases in money supply or

credit.

Cost-push Prices increased by producers to cover

higher costs of production. Supply shocks such as changes in oil prices,

crop failures & natural disasters.

Inflation & Expectations

Consumers Expect future inflation

Buy now. Expect low inflation

Delay purchases.

Producers Expect inflation

Raise prices.

Measuring Inflation CPI – Consumer Price Index

Market basket of goods CPI’s basket represents the entire

economy. Measures same goods every year. Tracks changes from year to year.

PPI – Producer Price Index Measures goods & services bought.

The Market basket

The Market Basket What goes into the CPI?

Housing 39.6% Transportation 17.6% Food 16.3% Entertainment 6.1% Medical Care 5.6% Education and Communication 5.5% Apparel and Upkeep 4.9% Other 4.3%

Calculating CPI Step One: Set Market Basket Step Two: Calculate CPI

P1*Q1+P2*Q2+…+PN*QN=CPI

Step Three: Convert to base year

CPICY/CPIBY*100

Calculating Inflation Rate

Equals rate of change of CPI’s I = (CPIY2 – CPIY1)/CPIY1*100 Example:

Year A CPI = 140 Year B CPI = 145 I = (145-140)/140*100 = 3.57%

Yearly CPI numbers 2009 211.14 1999 164.30 2008 211.08 1998 161.60 2007 202.42 1997 159.10 2006 198.30 1996 154.40 2005 190.70 1995 150.30 2004 185.20 1994 146.20 2003 181.70 1993 142.60 2002 177.10 1992 138.10 2001 175.10 1991 134.60 2000 168.80 1990 127.40

Inflation & the dollar

Interpreting Inflation rates Moderate

1 to 3 percent. Historically

3.41 % (since 1913) Double digit inflation

Considered high in developed countries Hyper inflation

Runaway inflation, can reach rates in excess of 100%.

5 Major Effects of Inflation

Decreased purchasing power Decreased value of real wages Increased interest rates Decreased savings & investing Increased production costs

Decreased Purchasing Power

Purchase less for same amount. Affects People on Fixed-Incomes.

Pensions, disabilities. COLA’s

Cost of living adjustments.

Decreased Value of Real Wages

Nominal vs. Real wages

Typically, wages increase more than inflation

Huge issue if real wages decrease

Increased Interest Rates

Interest rates reflect Expectations on future value of the

dollar Demand for money Profits

Effects of high interest rates Decrease in consumer spending Credit card costs increase

Decreased Savings & Investments

Savings Real value of money less Value of savings therefore less

Investing Need for higher returns to compensate

for inflation. Cheaper to purchase now b/c of stronger

dollar – decreases amount for investing.

Increased Production Costs

Most businesses operate with short-term or market pricing on costs.

Inflation hits production costs quickly. Long-term debt at lower rates one as

benefit of inflation for companies.