Inflation

Economics 120

Inflation

Inflation – sustained rise in the general price level or a fall in the purchasing power of money

Deflation – decrease in the general price level (Great Depression in 1930s)

Three Types

Creeping Inflation

Galloping Inflation

Hyperinflation

Creeping Inflation

Inflation that moves slowly and steadily (1%–4% annually).

Most people consider inflation to be an evil concept, but most economists believe that an annual rate of inflation of 1%–4% is not only good, but also necessary to allow for economic growth and an expanding population (advantage); however, it must be carefully controlled (disadvantage).

Galloping Inflation

This occurs when inflation starts to get out of control. (10%, 15% . . .)

The value of the dollar drops more quickly and prices double faster.

The last time this occurred in Canada was during the mid-1970s to early 1980s.

Hyperinflation

Inflation that is out of control (>50% per month) prices double quickly money becomes useless monetary system is likely to be destroyed economic system becomes chaotic.

This occurs when a population loses all faith in the economic system.

If serious inflation becomes a major problem, some governments will simply print more money to cover the higher prices which causes inflation to rise even more rapidly.

Hyperinflation

The most famous case occurred in Germany, in the years following World War I.

Inflation began in 1919 and by November of 1923, prices had risen to 1 422 900 000 000 times what they had been in 1914.

The government introduced a new currency that required 1 trillion units of old money for 1 unit of the new.

In recent years (1980s), Israel, Argentina and Bolivia have all suffered hyperinflation.

Hyperinflation

Germany in 1923 when the rate of inflation hit 3.25 × 106 percent per month (prices double every two days).

Greece in 1941-1944, when the rate of inflation hit 8.55 × 109 percent per month (prices double every 28 hours).

Yugoslavia's rate of inflation hit 5 × 1015 percent inflation between 1 October 1993 and 24 January 1994 (prices double every 16 hours).

The most severe known incident of inflation was in Hungary after the end of World War II, peaking at 4.19 × 1016 percent per month (prices double every 15 hours).

500 Billion

Yugoslavia, 1993

100 Billion

Germany, 1923

1 Milliard (1,000,000,000,000,000,000,000 )

1 x 1021

Hungary, 1946

Zimbabwe

Timeline

March 2007 – monthly inflation passed to 50% mark (hyperinflation)

December 2008 – inflation hit 6.5 quindecillion novemdecillion percent - 65 followed by 107 zeros. (Prices double every 24.7 hours)

January 2009 – issued a 1 trillion dollar banknote

Built in expiry date Worth 2 loaves of bread

Two Causes

Demand-Pull

Cost-Push

Demand Pull

Demand-pull inflation happens when people's incomes rise, but the amount of goods and services in the marketplace remain the same.

Since people have more money to spend, they are willing to pay more for goods and services. In other words, the total demand will go up, which will cause prices to rise.

Demand-pull inflation has been described as "more money chasing the same amount of goods."

Demand-Pull

Demand-pull Inflation can be represented by the equation MV=PQ. M is the amount of money available to spend, V is the velocity that the money is spent at, in other

words how many times one dollar is spent as it circulates through the economy,

P is the price of an item, Q is the quantity of items available in the

marketplace.

Demand-Pull

If M rises, then mathematically either the prices (P) must rise, or the amount of goods (Q) must rise, or the velocity of spending (V) must go down.

If the money supply increases, and the amount of goods and the velocity of spending stay the same, prices will go up.

Cost-Push

Prices rise as a result of increased production costs. Labour costs generally make up the largest portion of the

cost of production of most goods and services. In trying to improve their standard of living or to protect

themselves from expected inflation, workers will demand higher rates of pay, causing the production costs to rise and thus creating a form of inflation.

Inflation

In general, inflation hurts people. When prices rise, people can't buy as many things with

their money. People on a fixed income (an income that doesn't

increase when the cost of living goes up) are especially hurt, since the things they need to survive have increased in price, but their incomes don't increase.

Businesses are hurt, since they can't invest as much in the business, and it's difficult to plan for the future if you don't know what the value of the dollar will be.

Inflation

Some people are helped, however, and those people helped are people in debt (people who owe money).

If someone borrows money, and inflation causes the value of money to go down, then the money they pay back won't be worth as much as when they borrowed it. They essentially are paying less money back then they borrowed.