the effects of inflation and deflation on different groups

Scary!• The dollar has lost 56% of it’s value

since 1992.

• Or, a dollar today will buy the same amount of stuff as $0.64 would buy in 1992.

What has happened t the value of our money?

From year to year, a dollar then vs. a dollar now.

Inflation

• Inflation: P , $ value

• Deflation: P , $ value

• Stagflation: recession + inflation at same time.

• For the last 50 years, the U.S. has had an avg. inflation rate of 4% /yr.

So let’s say

• You get a raise of 5% this year.

• But inflation was 5% this year.

• Your nominal pay rose.

• What happened to your PURCHASING POWER???

• IT STAYED THE SAME

Stories of extreme inflation

Note those who are helped, and those who are hurt.

Story Time

• Once upon a time in Burgerland…

• There were only four jobs:– Beefers (cowboys)– Bakers– Burger store managers– Bankers

• And only one product…

• BURGERS.

For as long as anyone can remember…

• The price of a burger has been $1.

• All of the burger joints voluntarily charge $1.

Bill the baker wants to expand his business

• So he borrows – $10 from Brenda the banker, – at 20% simple interest (fixed rate),– to be paid back in one year.

• That’s $12!• What is Brenda’s profit?• How many burgers will Brenda be able to buy

with her profits?• (All of the burger joints voluntarily charge $1.)

But, before Bill is due to pay Brenda…

• The burger store managers (Bruce, Belinda, Barry, and Bedelia) unexpectedly raise their prices from $1 to $2 a burger!!

• Who is hurt by this change of events?• Who is helped?• How could Brenda have kept from getting

hurt?

If Brenda had charged• 20% interest• PLUS• the rate of inflation (called an adjustable

rate loan)

• She would have come out better.• Prices doubled. That’s 100% inflation.• A loan of $10, paid back plus 120% interest

would be $22

Unexpected Inflation

• Hurts:–lenders at fixed rates

–savers at fixed rates

–fixed-income recipients

• Benefits:–borrowers at fixed rates

Reminders/Hints

• A bond is a loan.– If I buy a bond from Coca-Cola, I’m loaning them

$.– They sold me a bond, so they’re borrowing from

me.

• Dividends are profits paid to stockholders. When prices rise, dividends rise.

• Income tax is a percentage of your income.– When prices rise, incomes rise.

Causes of Inflation

• Increase in money supply (MV=PQ)

• War

• More demand

Constructing a Price Index

• Inflation can distort GDP from year to year.

• A price index measures P changes.

• Select goods & services for a “market basket.”

• Add the price of each of these goods, to get the “base-year market basket price.”

• Find the market basket price at regular intervals (monthly, yearly, etc.).

Math Review

• Percent Change

• the formula: [(new-old)/old] X 100

• so if something increases from 5 to 7, the percent change is

• [(7-5)/5] = 0.4 = 40%

Constructing a Price Index-Continued• Price index =

• (selected basket price/ base yr. basket price)X100

• The base-year price index always = 100!

• Inflation =

• % change in price index, [(new-

old)/old]

Inflation between ‘84 & ‘98:

(163-100)/100 = 0.63 = 63%

Inflation between ‘98 & ‘03:

(183.7-163)/163=0.13=13%

Prices in 1999 Prices in 2009• Peanut butter (lb.)- $1.77

• White flour (lb.)- $0.30

• White bread (lb.)- $0.87

• Chocolate chip Cookies (lb.)- $2.61

• Ground beef (lb.)- $1.38

• Pork chops, center cut, bone-in, per lb.- $2.95

• Bologna, all beef or mixed, per lb.- $2.41

• Chicken breast, bone-in, per lb.- $2.07

• Cheddar cheese, natural, per lb.- $3.75

• Apples, red delicious, per lb.- $0.86

• Bananas, per lb.- $0.49

• Tomatoes, per lb.- $1.90

• Lettuce, iceberg, per lb.- $0.65

• Beans, dried, any type, all sizes, per lb.- $0.69

• Coffee, 100%, ground roast, all sizes, per lb.- $3.44

• Average electric bill per month- $84

• Gasoline, unleaded, per gallon/3.785 liters- $0.97

• Movie ticket- $5.06

• US postage stamp- $0.33

• Bacon (lb.)- $2.59

• Dozen eggs- $0.89

• Average rent/housing payment per month- $645.00

• Peanut butter (lb.)- $2.14

• White flour (lb.)- $0.52

• White bread (lb.)- $1.38

• Chocolate chip Cookies (lb.)- $3.11

• Ground beef (lb.)- $2.36

• Pork chops, center cut, bone-in, per lb.- $3.39

• Bologna, all beef or mixed, per lb.- $3.11

• Chicken breast, bone-in, per lb.- $2.46

• Cheddar cheese, natural, per lb.- $5.01

• Apples, red delicious, per lb.- $1.23

• Bananas, per lb.- $0.63

• Tomatoes, per lb.- $1.66

• Lettuce, iceberg, per lb.- $0.94

• Beans, dried, any type, all sizes, per lb.- $1.40

• Coffee, 100%, ground roast, all sizes, per lb.- $3.68

• Average electric bill per month- $126

• Gasoline, unleaded, per gallon/3.785 liters- $1.79

• Movie ticket- $7.50

• US postage stamp- $0.42

• Bacon (lb.)- $3.22

• Dozen eggs- $1.37

• Average rent/housing payment per month- $780.00

Major Price Indexes

• Consumer Price Index (CPI)-90,000 items in 364 categories.

• Implicit GDP Price Deflator- all goods/services. Base year 1996.

Does Government Spending affect the CPI???

• Lets take a look at Government Debt and deficits and see if we see a

correlation.

I. Real GDP• GDP adjusted for inflation.

• Real GDP=• [GDP from year Y/(price index from year Y)]X100

• This formula sets dollars equal to base year.

I. Real GDP• Listen:

• If GDP in 2003 was $10.6 trillion, and the GDP deflator was 111.9, what was the Real GDP?

• [$10.6 trillion/111.9]X100= $9.5 trillion

• $9.5 trillion is 2003 GDP measured in 1996 prices.

Causes of Inflation

• Demand-pull inflation• Cost-push inflation -

during stagflation• Growth in money supply.• Wage-price spiral - higher

Ps, then higher wages, then higher Ps...

Inflationland• In Inflationland, they have inflation at the

relatively high rate of 7% a year.• The inflation rate is always 7%.• Banks expect inflation to stay at 7%, and

make decisions accordingly.• Businesses give all workers a 7% raise every

year.• The government raises taxes 7% every year.• Who does inflation hurt in this country????

The oil crisis of 1973 caused stagflation. High oil prices caused a recession and inflation at the same time.

High inflation + falling real GDP = STAGFLATION

Questions?