Mod.4- INFLATION.pptx

7/22/2019 Mod.4- INFLATION.pptx

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INFLATION


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Definition

A sustained, rapid increase in prices, as

measured by some broad index(such

as Consumer Price Index)

over monthsor years, and mirrored in the

correspondingly decreasing purchasing

powerof the currency.
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How Inflation Is Measured?

To measure inflation, a number of goods that

are representative of the economy are put

together into market basket.

It is then compared over time. This results in a

price index. Price index shows the changes in

the cost of the present market basket as a

percentage of the cost of that identical basketin the previous year.


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Price Indexes

There are two main price indexes that measureinflation:

Consumer Price Index(CPI)A measure of price

changes in the retail market of consumer goods

and services such as petrol, food, clothing and

automobiles. The CPI measures price change

from the perspective of the retail buyer.

It is the real index for the common people. Itreflects the actual inflation that is borne by the

individual. This is not taken into consideration in

India.


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Price Indexes

Wholesale Price Index (WPI): It is used in

India. It takes into account the rise in prices of

goods and services in a select range of goods

and services at the wholesale level.

Since the general public does not buy at the

wholesale level, it does not give the actual

feeling of the amount of pressure borne bythe general buyer.


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Measuring Inflation

The CPI can be thought of as an

imaginary basket of selected

goods and services bought by a

typical capital city household.

The CPI is merely a measure of the

changes in the price of this basket

of goods and services.


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7

Measuring Inflation

The price of the CPI

basket in the base (first)

period is given a value of

100 and the prices of

subsequent periods are

compared against the

base year.


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8

Measuring Inflation

For example, if the price of the basket had

increased 15% since the base year, the CPI

would read 115, if the price had fallen by 15%

since the base year the CPI would be 85.


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9

Measuring Inflation

It is important to remember that the CPI

measures price movements and not actual

price levels.


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10

Measuring Inflation

For example, if the index for

beer is 108 and the

corresponding index for wine

during the same period is 104

it doesnt mean that the price

of beer Is more expensive than

wine.


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Measuring Inflation

It means that the price of beer hasincreased twice as much as that of wine

since the base year.


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12

Measuring Inflation

Compilation of the CPI

involves a quarterly survey

of a basket of goods and

services representing a

high proportion of

household expenditure.


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Measuring Inflation

The basket of goods and services

upon which the CPI is based is

divided into 8 groups. Which are

further divided into a number of

sub-groups and then into specific

expenditure classes.


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Measuring Inflation

The eight groups of the CPI are as follows:

Food

Clothing

Housing

Education and Recreation

Transportation

Health and Personal Care Household Equipment and Operation


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Measuring Inflation

To reflect the importance of each

expenditure class in relation to

total household expenditure,

weight or measure of relative

importance to each expenditure

class in the CPI, are attached to

each item in the index.


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Measuring Inflation

Weights are compiled as a result of extensive

surveys of patterns of consumption and are

revised every 5 years to take account of

changes in expenditure patterns.


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Measuring Inflation

The usefulness of an

index number in statistics

is to allow comparisons of

data between one period

and another, using a

common unit of

measurement.


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Constructing the CPI Index

Period 1 Period 2

Commodity Weight Price WXP Price WXP

Food 40 0.65 26 0.80 32Clothing 30 0.70 21 0.80 24

Housing 20 1.15 23 1.15 23

Recreation 10 1.00 10 1.10 11

Total 100 80 90

Price Index 100 112.50


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Inflation

Measured by:

CPI = price of the most recent market basketin a particular year

price estimate of same market basket

in 1982-1984


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Inflation

Percent increase in CPI =

[(CPI in current yearCPI in previous year)][CPI in previous year]

all*100


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Inflation

From 1972 to 1982, the consumer price index

rose from 125.3 to 289.1

By what percentage did the cost of living rise?


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Inflation


[(289.1125.3][125.3]

*100

=130.7%


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Inflation

The CPI rose from 114.3 in 2013 to 126.1 in

2020.

By what percent did the CPI rise?


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Inflation


[(126.1114.3][114.3]

*100

=10.3%


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Inflation

The CPI rose from 200 in 1991 to 240 in 1997.



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Inflation

The CPI rose from 129.6 in 2029 to 158.3 in

2045.



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Inflation


[(240200][200]

*100

=20%


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Inflation


[(158.3129.6][129.6]

*100

=22.1%


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Calculating Inflation

Year 2 cost x 100

= Therefore

Year 1 cost 1

90 x 100= 112.5

80 1


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Calculating Inflation

112.5100 (Base Year) = 12.5 %

From this we can say over the year, averageprices increased by 12.5 %.


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Inflation

Inflation is a steady andupward movement inthe level of prices,

decreasing purchasingpower, over a givenperiod of time, usuallyone year.


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Demand Pull Inflation

Demand Pull Inflation occurswhen Aggregate demand(C+I+G+(X-M)) increases at a

rate faster than the capacity ofthe economy to produce goodsand services ie: AD>AS. Thisincrease competition for goods

and services drives up theirprices.


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P2

P1

Q2Q1

Aggregate Supply

Aggregate Demand 2

Aggregate Demand 1

Price

Real GDP


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An increase in demand shifts the aggregate

demand curve to the right, from AD1to AD2

pushing up the price level from P1to P2.


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Sources of


Any increase in Aggregate Demand (C + I + G

+ ( XM ) ) as the economy approaches full

employment.


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Sources of


Full employment causeslabour shortages,employers thus bid up

wages to attract labour.The increased income,transpires into increasedconsumption causing

Aggregate Demand to rise.


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Sources of


High levels of foreign investment increases

employment, income, consumptions and

ultimately Aggregate Demand.


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Sources of


Growth in foreign

economies can lead to

higher incomes for ourexporters, thus allowing

increases in Aggregate

Demand.


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Sources of


Inflationary expectationsIf members of aneconomy expect prices to

rise, it brings forwardexpenditure decisionsleading to demand pullinflation eg: Pre GST in

Australia.


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Sources of


Monetary considerationtoo much credit in the

economy. A relaxed monetary policy leads to a

reduction in interest rates leading to an increasein Aggregate Demand and thus prices.


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Cost Push Inflation

Cost Push Inflation occurs

when prices are pushed up by

rising costs to producers who

compete with each other forincreasingly scarce resources.

The increased costs are passed

onto consumers.


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Cost Push Inflation

P2

P1

Q2 Q1

Aggregate Supply 2

Aggregate Demand

Price

Real GDP

Aggregate Supply 1


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Cost Push Inflation

An increase in the prices of inputs shifts the

aggregate Supply Curve to the left, from AS1

to AS2pushing up the price level from P1to

P2.

f


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Sources of

Cost Push Inflation

Any input may become a major cost to

business eg: wage increases lead to higher

production costs.

f


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Sources of

Cost Push Inflation

Labour shortages in some sectors necessitate

wage increases in that sector, however it has

a domino effect leading to wage rises in

other sectors.

S f


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Sources of

Cost Push Inflation

NB: Wage rises in excess ofproductivity increase leads toinflationary pressure.

The extend to which a producer canpass on price rises depends on thelevel of competition in the industry.

The more competitive the industry,

the more the producer has to absorbcosts rather than pass them ontoconsumers.

S f


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Sources of

Cost Push Inflation

Inflation imported fromabroad, eg: the rise in thecost of intermediate goods

and resources importedfrom other countries flowsthrough in the form ofhigher prices domestically

eg: oil prices.


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Inflation

Who is hurt by inflation?


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Who is Hurt by Inflation

PEOPLE ON FIXED INCOMES

LENDERS/CREDITORS


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Who is Hurt by Inflation:

People on Fixed Incomes

Nominal Income

Real Income


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Wh i H t b I fl ti


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Nominal vs. Real Income

% CHANGE IN REAL INCOME =

% Change Nominal Income - % Change Price Level

Wh i H t b I fl ti


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Nominal vs. Real Income

Fixed income receivers

Anyone who income is fixed over time finds that

their real income falls at the same rate that

inflation rises.



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Lenders/creditors

Lenders, such as banks and credit card companies,

lend money to earn a profit.

To earn a profit, the interest they charge must

cover all costs, and be higher than the rate of

inflation.



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Lenders/creditors

When lenders lend money, they have an expected

rate of inflation at the time of the loan.

This expected rate of inflation is based on

current rate of inflation, plus a guess about the

future.



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Lenders/creditors

If lenders guess right about inflation, they earn a

profit.

If lenders guess wrong, they lose money.



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Lenders/creditors

Nominal interest rate = the observed

interest rate

Real interest rate = nominal interest rate

rate of inflation



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Lenders/creditors

If inflation is less than the nominal interest rate,

lenders earn a profit.

If inflation is greater than the nominal interest

rate, lenders suffer a loss.


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Inflation: Any Winners?

Not everyone loses with low and moderate rates

of inflation.

- People whose income is flexible.

- Borrowers (debtors).


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Inflation: Any Winners?

Borrowers win because the real value of their

loan repayments decreases at the same rate

as inflation rises.

If their incomes rise as well, they are double

winners.

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Mod.4- INFLATION.pptx