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Ch.

14: Inflation
CIE3M1-01
M. Nicholson

What Is Inflation?
Inflation

is the increase in the


prices of goods & services over a
period of time
Figure 14.1 pg. 290
comments?

How To Increase Your Income


Without Doing More Work
Cost

of living allowances can be


calculated in the following
manner:
(Costs Today / Past Costs) x 100%
Gas = $1.25 / $0.50 x 100% =
250%

The Consumer Price Index


CPI

is a measure of the general


changes in market prices of a selected
group of goods & services (< 400)
purchased by the typical urban (>
30,000) family
Products are weighted according their
proportion of total household
expenditures with seven components
(food 18.1, housing 36.3, clothing 8.7,
transportation 18.3, health 4.2,
recreation and education 8.8, tobacco /
alcohol 5.6)

The Consumer Price Index


Current

base year 1986 given the


number 100 whereas 1990 is
117, which means there was 17
% inflation (Current Year CPI /
Base Year CPI x 100%)
CPI, GDP and unemployment rate
are the three most commonly
used indicators of how the
Canadian economy is doing

Inflation Since 1940


1940

42 prices rose rapidly


because of WW 2
1943 45 government controlled
prices
1946 49 rapid price increase
with end of war
1951 Korean War drove up prices

Inflation Since 1940


1.
2.
3.
4.
5.
6.

1953 65 (low inflation of 1.5%)


1966 72 (higher inflation of
4.8%)
1973 82 (9% inflation)
1983 91 (< 5% inflation)
1991 (low inflation of < 2%)
Figure 14.5 pg. 293 #1 - 3

Inflation: The Winner &


Losers

Those who owe money (borrowers)


win and those who are owed money
(lenders) lose
Inflation Race expanding
businesses, workers in powerful
bargaining positions, and those who
borrowed money are the winners
Declining industries, workers in
weak bargaining positions, and
those on fixed incomes lose

Inflation: The Winner &


Losers

Inflation shifts benefits from


creditors to debtors
Hyperinflation or extremely high
rates of inflation devastates an
economy causing money to become
worthless people turn to barter
destroying benefits specialization
(higher quality, cheaper products
and more leisure time)

Inflation: The Winner &


Losers
Deflation

decrease in the
general level of prices over time
(Depression 1930s)
Pgs. 301 302 #1 - 2

What Causes Inflation?


Full

employment and no inflation


is the ideal situation (i.e. full
bucket)
Bucket shows real output which
is adjusted for inflation so that
different years outputs can be
compared

What Causes Inflation?

Demand-Pull Inflation
If

full employment exists (full


bucket) and injections (X + I + G) >
leakages M + S + T) then no more
goods & services can be produced,
only prices will rise (inflation, water
spilling out of the bucket)
Demand for goods & services >
quantity of goods & services pulls
up prices

Demand-Pull Inflation

Government Policies to
Control Demand-Pull Inflation
Contractionary Fiscal Policy G
and T govt revenue for
use during a recession
2. Contractionary / Tight Money
Policy Sell bonds, the bank
rate and use moral suasion to
discourage bank loans
3. Pg. 303 #3 - 5
1.

Applying Fiscal & Monetary


Policy To Demand-Pull
1. Unemployment the biggest
Inflation

negative consequence of
controlling inflation with
contractionary policies
2. Delays in applying the policy
recognition lag; decision lag;
implementation lag

Cost-Push / Sellers
Inflation
resource

costs (e.g. ,wages)


increase producers pass on the
increased costs to consumers in
the form of higher priced
products
The worst situation is the twin
evils of inflation & unemployment
existing at the same time
stagflation

Cost-Push / Sellers
Inflation
Stagflation

- occurred in the
1970s when OPEC raised the
price of oil which was an
essential source of energy for the
Canadian economy (e.g. bucket
has holes on the side that leak)
Oil Crisis Video

Cost-Push / Sellers
Inflation

Income vs. Expenditure


Method Of Measuring The
C + I + G + (X M) = GDP
Economy

Expenditure Method
M (supply of money) x V (velocity
of circulation of money) = GDP
GDP = P x Q MV = PQ
Recession M x V = P x Q
Full Employment M x V = P
xQ

Income vs. Expenditure


Method Of Measuring The
Monetary Rule economist Milton
Economy
Friedman believed that the
money supply (M) should only be
increased by the same amount as
the increase in the amount of
GDP which would solve the
problem of inflation
% GDP = % M

Income vs. Expenditure


Method Of Measuring The
Keynesians believe in using G
Economy

and T to solve the problems of


the economy
Monetarists believe G and T
cause more problems than they
solve and the economy would be
healthiest if money supply grows
proportionally with GDP

Wage & Price Controls


Policies

aimed at restraining
inflation by holding wages and
prices below a specific level
Successful controls during WW 2
but unsuccessful controls in the
1960s and 70s. Video

Wage & Price Controls


1.
2.
3.
4.

lack of united support


large bureaucracy needed
interference with the operation
of the market
import prices
all contributed to the lack of
success

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