Inflation

General terms
DEFLATION = opposite to inflation, occurs when the general

level of prices is falling DISINFLATION = describe the process of reducing a nations rate of inflation STAGFLATION = high inflation in periods of high unemployment REVALFLATION = impact of inflation, where the result is an inner valorisation of exchange rate
Rate of inflation

i yeart

price level yeart price level yeart 1 price level yeart 1

PRICE INDEXES

Consumer price index (CPI) - each item is assigned a fixed weight proportional to its relative importance in consumer expenditure budget
CPI

Q Q

P1 P0

100

Producer price index (PPI) - measures the level of prices at the wholesale or producer stage GDP deflator the ratio of nominal GDP to real GDP can be interpreted as a comprehensive price index
GDP deflator

Q P Q P
1 1

1 0

100

Numerical Example
Calculate the consumer price index and the rate of inflation for 2006.

Base year (2000) Weigh (%) Price Food Shelter Medical care 20 50 30 100 100 100

2006 Weigh(%) Price 20 50 30 102 106 110

Categories of Inflation according to its pace/rate:

MODERATE INFLATION occurs when prices are

rising slowly (we might classify this as single-digit annual inflation rates 0-10 % per year) GALLOPING INFLATION - occurs when prices start rising at double-or-triple digit rates (20, 100 % a year) HYPERINFLATION the extraordinary price increase (at annual rate of 100 % or more prevailing in a nation for at least one year)

Inflation according to:

a) its impact on individual commodity:
Balanced leaves relative

b) predictability Anticipated Unanticipated

prices unchanged all prices are rising at the same percentage point each year it doesnt cause a change in consumption structure Unbalanced some prices are increasing faster than the general price level there can be seen an expressive impact on the demand and consumption structure

Inertial inflation = tends to

stay at its prior rate until shocked by economic events.

IMPACT OF INFLATION cost of inflation

1) Redistribution of income and wealth

2) Social impacts 3) Impact on balance of economy

SUMMARY OF IMPACTS
there is no effect on real output, efficiency, or income

distribution of an inflation that is both balanced and anticipated generally, the economic impact of an unanticipated moderate inflation is mainly on the distribution of income and wealth, and less on the efficiency of the system the mildest impact will be found when inflation is at a low rate small, anticipated and balanced major social and economic impacts arise for galloping inflation or hyperinflation

Causes of Inflations
1.DEMAND-PULL INFLATION - the essence of demandpull inflation is too much spending beating against a limited supply 2. COST-PUSH INFLATION first appeared during the 1930s and the 1940s inflation caused by continual decrease in aggregate supply

THE PHILLIPS CURVE

the Phillips curve depicts the relationship

between unemployment and inflation, both in percent SHORT-RUN PHILLIPS CURVE a nation could buy a lower level of unemployment if it were willing to pay the price of a higher rate of inflation

The shifting Phillips curve

Boom cycle

Period 1: unemployment is at the natural rate; no demand or supply

surprises; economy is on the lower short-run Phillips curve

Period 2: rapid increase in output during an economic expansion (f. e.

as a result of expansion policy) lowers the unemployment rate wages and prices begin to accelerate the economy moves up and to the left along the short run PC
Period 3: Firms and workers begin to expect higher inflation higher

expected rate of inflation gets incorporated into wage and price decisionsthe short-run PC shifts upward
Period 4: unemployment rate returns to the natural rate; contraction in

economic activity brings output back to its potential.

The vertical Long-Run Phillips curve

When the unemployment rate diverges from the

NRU the inflation tends to change According to the natural rate theory, the only level of unemployment consistent with a stable inflation rate is the natural rate of unemployment the long-run PC is a vertical line rising straight up at the NRU

Two important implications for economic policy:

1) there is a minimum

level of unemployment that an economy can sustain in the long run; 2) the nation can temporarily enjoy low rate of unemployment, but at the expense of rising inflation

WAYS (COSTS) OF DISINFLATION: Temporary increase in unemployment above the NRU Income policies (wage- price control or voluntary guidelines)

1. Calculate the CPI and IPD, if following amount of products was consumed in economy:

Product
A Price 16

B C

820 3 600

1.Year Quantity 120 000 31 000 290

Price 21

815 4 050

2. Year Quantity 142 000 33 100 270