Module 14
Inflation
General rise in prices over time.
Inflation has an effect on wages, income, and borrowing.
Inflation rate = (Price level of year 2 - price level of year 1) / price level of year 1 * 100%
Causes of Inflation
Consequences of Inflation
Erodes purchasing power.
Shoe leather cost
- When there is inflation, people do not want to hold money, because that money is losing value.
- The costs of transaction of moving money into different accounts to reduce the effects of inflation.
Unit-of-account costs - Makes money a less reliable unit of measurement.
Real Wages
Wages adjusted for inflation.
Q: If the price level of the economy increase by 6%, and your nominal wage goes up by 4%, what has happened to your real wage?
A: 2% decrease.
Real Income
Income adjusted for inflation.
Borrowing Money
Money is lent out on a nominal interest rate.
If inflation is higher than expected, borrowers win as they are paying money back with money that is effectively worth less.
Disinflation
Not deflation - When you take inflation rate into the negatives. Accompanied by economic depression.
The process of bringing the inflation rate down.
In order to do so, you have the induce people to stop spending money.
- To do this, you raise interest rates.
The true cost of a higher disinflation rate, is a higher unemployment rate.
- Governments can cause a recession on purpose to do so.