Unit 2: Inflation 2/6/17

Inflation: General rising level of prices

- Reduces Purchasing Power of money

Purchasing Power: The amount of goods & services that money buys

Deflation: A decline in the general price level

Disinflation: Occurs when the inflation rate itself declines

Three Causes of Inflation:

1) Printing too much money
2) Demand-Pull Inflation:
"Too many dollars chasing two few goods"

• Demand pulls up prices!
• Demand increases but supply stays the same. The result is a shortage driving up prices
• An overheated economy with excessive spending but same amount of goods.

3) Cost-Push Inflation

• Higher production costs increases prices

Inflation Formula:

Current Year Price Index - Base Year Price Index     X 100

              Base Year Price Index

Hurt by Inflation:

• Lenders- people who lend money (at fixed interest rates)
• People with fixed incomes
• Savers

Helped by Inflation:

• Borrowers- people who borrower money
• A business where the price of the product increases faster than the price of resources

Rule of 70:

Used to calculate the number of years it will take for the price level to double at any given rate of inflation.

Formula =              70                   

                Annual Rate of Inflation

Real Interest Rate: Deals with the amount of money that is borrowed. Adjusted for inflation.

 Real= Nominal Interest Rate - Expected Inflation

Nominal Interest Rate: The percentage increases in money that the borrower pays back to the leader not adjusting for inflation.

Ideal Interest Rate: 2 to 3%