1.06 Understand economic indicators to
recognize economic trends and
conditions
Describe the economic impact of inflation on
business
INFLATION
 A persistent increase in the average price level in the economy.
 It is measured by the inflation rate
 Inflation is the most common phenomenon associated with the price
level.
 Inflation is one of two key macroeconomic problems. The other is
unemployment.
Causes of Inflation
 Inflation occurs when the AVERAGE price level (that is, prices
in general) increases over time.
 This does NOT mean that ALL prices increase the same, nor that ALL
prices necessarily increase. Some prices might increase a lot, others a
little, and still other prices decrease or remain unchanged.
 Inflation results when the AVERAGE of these assorted prices
follows an upward trend.
 While short-term bouts of inflation can be triggered by anything that
would cause aggregate demand to increase more than aggregate supply
 long-term inflation can be sustained ONLY through increases in the
money supply. The price level, and any "inflation" of the price level,
depends directly on the amount of money in circulation. On the flip side
of this relationship, inflation leads to a continual erosion in the purchasing
power of money.
INFLATION RATE
 The percentage change in the price level from one period to the next.
 The inflation rate is most commonly presented as an annual average, the
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percentage change in the average price level from one year to the next.
The two most common price indexes used to measure the price level
and the inflation rate are the Consumer Price Index (CPI) and the GDP
price deflator.
The inflation rate is one of several key indicators of business-cycle
instability and the overall health of the macroeconomy, with primary
focus on tracking the goal of price stability.
The inflation rate, measured as the percentage change in a price index
such as the Consumer Price Index or the GDP price deflator, seeks to
quantify changes in the average price level.
While the inflation rate is generally positive, indicating inflation, it also
can be negative, indicating deflation. Should a positive inflation rate
decline over time, then disinflation occurs.
DEFLATION
 A persistent decrease in the average price level in the economy.
 deflation occurs when the AVERAGE price level decreases over time.
 While some prices might decrease, other prices could increase or remain unchanged,
 deflation occurs if the AVERAGE follows a downward trend.
 Deflation is a rare phenomenon indeed in the economy and typically happens during
prolonged periods of
 (1) contractionary stagnation or
(2) technological-induced expansion.
 Deflation could appear during a fairly lengthy recession or occasional depression, when aggregate demand has
dried up substantially.
 With no one buying goods, producers reduce prices and deflation results.
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 Deflation also can emerge during expansionary periods driven by significant
technological advances, when the economy has the ability to provide more production at
lower cost. Following declining production cost, the price level also falls and the result is
deflation..
DISINFLATION
 A decline in the inflation rate.
 prices continue rising, just not as fast.
 Numerically speaking, disinflation occurs if the inflation rate
over three consecutive years is 10 percent, 6 percent this
year, and 4 percent.
 a reduction in the inflation rate, is not the same as deflation,
which is an actual decline in the price level.
 Should disinflation continue, presumably due to antiinflationary monetary or fiscal policies, then the average
price level might eventually decline, making the transition
from disinflation to deflation.
Problems of Deflation
 create uncertainty and a haphazard redistribution of income just like
inflation.
 Uncertainty
 If prices unexpectedly decline, then consumers and producers alike might be
less willing to pursue long-term activities, because they just do not know
what will happen to the price level.
 Haphazard Redistribution:
 haphazardly redistribute income and wealth just like inflation. If some prices
decrease more than others, then income and wealth is redistributed to the
owners of those resources with the smaller price decreases.
 deflation occurs when the aggregate demand for production persistently
falls short of the aggregate supply of production.
 While a number of factors can trigger such an imbalance, persistent deflation
is only possible in the long run if the money supply declines.
CONSUMER PRICE INDEX
 An index of prices of goods and services typically purchased by urban consumers.
 The Consumer Price Index (CPI) is compiled and published monthly by the Bureau of
Labor Statistics (BLS), using price data obtained from an elaborate survey of 25,000
retail outlets and quantity data generated by the Consumer Expenditures Survey.
 The CPI is one of two key price indexes used as a measure of the price level and to
estimate the inflation rate.
 The other is the GDP price deflator.
 The CPI is also officially designated as the Consumer Price Index for All Urban
Consumers (CPI-U).
 Another noted price index is the Producer Price Index (PPI).
 The Consumer Price Index (CPI) is unquestionably one of the most widely recognized
macroeconomic price indexes, running second only to the Dow Jones Industrial Average
in the price index popularity contest.
 It is used not only as an indicator of the price level and inflation, but also to convert
nominal economic indicators to real terms and to adjust wage and income payments
(such as Social Security) for inflation.