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Inflation:
◦ General increase in the general price level
throughout an economy
 Doesn’t mean the price of every product is
increasing
 Nor does a price increase in one or a few products
mean that there is inflation
Inflation Definition

Demand-Pull Inflation:
◦ Inflation caused by consumer demand for
goods and services increasing faster than the
ability of the economy to produce more goods
and services.
 Think about how an auction works…
Types of Inflation

Cost-Push Inflation:
◦ Occurs if business supplies less of the goods
and services because of increasing
costs…causing the price level to rise
◦ The increasing costs could result from higher
costs of inputs or because businesses expect
prices to go up and so produce less currently
◦ Ex: Fuel Costs for Airline Industry; Rise in
Rent/Energy/Wages for Businesess
Types of Inflation
Minimum Wage in 1985 was $3.35
If the wage rose at the same rate of
inflation, minimum wage today should
be…….
$6. 66
However, minimum wage is $7.25 federal
And Oregon’s is $8.80
Examples:
Effect 1: Decreasing Value of the Dollar
◦ Inflation reduces the purchasing power of the
dollar…as price level rises each dollar can buy less
Effect 2: Increasing Interest Rates
◦ Lenders raise interest rates to ensure profit on
loans
◦ Businesses avoid borrowing to expand or make
capital improvements
◦ Consumers less likely to finance high-priced items
What is the impact of inflation?

Effect 3: Decreasing Real Returns on
Savings
◦ Interest on savings tends to increase during
inflationary times
◦ Inflation worries people about drop in standard
of living, retirement (ie. Fixed Incomes)
What is the impact of inflation?
Best measure is the Consumer Price Index
(CPI)
 Measures how much prices of necessary
items are changing
 Allows for a comparison of avg. prices for
a group of goods over time


Avg. rate of inflation is 1%-3%
How is inflation measured?

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Food and Beverages - “Market Basket”
Housing
Apparel
Transportation
Medical Care
Recreation
Education
Communication
What goods and services does CPI
include?

Savers
◦ Households that have been saving money will
see the real value of their savings decrease

People on Fixed Incomes
◦ Cost of living will increase, however, their
income level will not…Causes a decrease in
their STANDARD OF LIVING
◦ Some people on fixed incomes have a COLA
 Cost of Living Adjustment (Social Security) that
rises with inflation
Who is hurt by Inflation?

Suppose you earn $1000/ yr.

The Inflation rate increases 10%,
therefore prices for goods increase. (A
$1000 item will cost $1100)

Your $1000 will not buy what the $1000
could buy the previous yr.
Example
• Inflation helps people who borrowed at a fixed
rate of interest
(the payment of the loan to be repaid will remain
the same; however prices for other goods may
have increased)
Who is helped by inflation?

Expecting inflation is a self-fulfilling
prophesy…WHY?
◦ When consumers expect prices to go up, they
buy more goods (Demand Shifts Right)…thus
creating Demand Pull Inflation
◦ When suppliers expect prices to go up, they
will decrease supply (Supply Shifts Left)… thus
creating Cost-Push Inflation
Expecting Inflation