Inflation+(IB)

Inflation

The meaning of inflation, disinflation and deflation

 * ==Distinguish between inflation, disinflation and deflation.==
 * ==Explain that inflation and deflation are typically measured by calculating a consumer price index (CPI), which measures the change in prices of a basket of goods and services consumed by the average household.==
 * ==Explain, giving examples,that different income earners may experience a different rate of inflation when their pattern of consumption is not accurately reflected by the CPI.==
 * ==Explain that inflation figures may not accurately reflect changes in consumption patterns and the quality of the products purchased.==
 * ==Explain that economists measure a core/underlying rate of inflation to eliminate the effect of sudden swings in the prices of food and oil, for example.==
 * ==Explain that a producer price index measuring changes in the prices of factors of production may be useful in predicting future inflation.==





Prep: This presentation looks into the causes of inflation using AD/AS. 

[|Inflation and Political unrest:]

Causes Of Inflation media type="youtube" key="eZbSOw26aO0" width="560" height="315"



Government Policies to cure Inflation



Extension reading 

Chinese interest rates

Measuring Inflation All students need to understand how inflation is measured but only HL students need to know how to calculate inflation. __Key points that all students need to understand: __ media type="youtube" key="JW7IQ45_up8" width="560" height="315"
 * The RPI/CPI is measured using a "basket of goods and services" and each category is weighted according to the % of our expenditure that we spend on each. See the video below:
 * RPI/CPI

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">media type="youtube" key="pRIELoITIHI" width="420" height="315"

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">media type="youtube" key="-JTw7gNwT6Y" width="420" height="315" <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px; line-height: 1.5;">All of the above are included p225-230 in the OUP textbook.
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Therefore the CPI or RPI is only a true cost of living if you are an average family. If you are very rich, very poor, single or an Old Age Pensioner then it may not give an accurate representation of your cost of living.[| In fact in the UK there is a cost of living index specifically for OAPs]
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Changes in consumption are taken into account in that weightings are periodically changed and new goods replace old goods, but these changes are retrospective and so may be out of date.
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Quality improvements cannot be taken into account.
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Core Inflation: <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px; line-height: 1.5;">Inflation data can often be distorted by seasonal factors and certain goods may have very volatile prices. Therefore this volatility may distort our inflation measures, and what may appear to be the start of significant inflation in an economy is merely a short term "blip". For example unseasonal rains may create food shortages which significantly pushes up their prices. However food supplies may recover quickly and food prices may quickly return to normal. The CPI/RPI data could have misled us into thinking that the price increases were long term, when in reality they were not. Therefore as an alternative to this measure we sometimes calculate "CORE INFLATION" which is the same as the CPI but excludes food and energy prices to reduce the volatility of the index
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Producer Price Index: <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px; line-height: 1.5;">One limitation of the CPI index is that its' use is limited in that Governments following the RPI may act too late to control inflation. It is an indicator that inflation has already arrived. Ideally governments want "leading indicators", which are things which predict what may happen in the future. So what would be a good leading indicator of future inflation? Producer price increases are one such lead indicator, as they indicate that consumer prices may increase in the future. The transmission of producer price increases to increases in consumer price increases often occurs with a significant time lag, as distributors and retailers often first reduce their profit margins before finally increasing the price they charge to consumers. The Producer Price Index is sometimes referred to as "Factory Gate prices" as they track the price of goods as they leave the factories and before distributors add their profit margins.
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px; line-height: 1.5;">Another alternative measure of Inflation is the GDP deflator that we came across when we distinguished between money and real GDP. The GDP deflator is a comprehensive price index which measures price changes of all goods and services included in the GDP of a country. It therefore differs from the RPI in that it includes capital goods but excludes imports.

__<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 18px;">HL Students only __ <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">A good starting point is to use the CPI as an example of a price index to explain how an index is calculated. <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Both the Dorton (P236-238) and McGee books have good examples of the whole process. <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Once you have worked through these examples with your teacher attempt the following example: <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 18px;">[|Answer]

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">An alternative way to calculate an RPI is this: <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">The weightings are not given but you are told that the basket purchased includes 10X, 20Y, and 30Z. To calculate a weighted price index you must first calculate the total cost of each basket assuming the quantities given. <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">From there the process is the same as before. Can you attempt this- calculate the indexes for 2010-2012 and work out the annual rate of inflation for each year.
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Year || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Price of Good X || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Price of Good Y || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Price of Good Z ||
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">2010 || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">8$ || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">0.6$ || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">$2 ||
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">2011 || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">$8.4 || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">$0.64 || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">$2.05 ||
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">2012 || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">$8.6 || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">$0.75 || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">$2.25 ||



<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 24px; line-height: 1.5;">Deflation

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<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Deflation refers to a decrease in the general price level of the economy. A fall in prices in particular markets, such as housing, share prices or the market for electronic goods or textiles is not the same as economy-wide deflation.

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Most economists believe that disinflation or falling inflation is beneficial for the economy. A stable price level can lead to better decisions and a more efficient use of scarce resources. Lower inflation also helps to stabilize inflationary expectations. But falling inflation should not be confused with deflation <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">One form of deflation may be seen as a good thing. A decline in prices after an improvement in productivity allows companies to cut costs and prices, thereby raising living standards. However this is a rare form of deflation. In most cases deflation occurs due to a lack of demand in the economy. <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">This type of deflation – caused by a lack of AD is often long-lasting, and symptomatic of a weak economy stuck in recession. We would show this cause of deflation using the following diagram: <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px; line-height: 0px; overflow: hidden;">

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">When prices are falling, consumers may decide to postpone purchases in the expectation of buying the item at a cheaper price later on. This causes a fall in demand and can create further price declines. <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Deflation also causes real interest rates to rise, curbing demand. As well, falling asset prices (including housing and equities) reduce personal sector wealth and inflate the real value of debt, resulting in higher business failures and personal bankruptcies. It is clear therefore that deflation in the economy brings risks as well as opportunities. This is something that a government and the monetary authorities (i.e. the Central Bank) might be concerned to avoid. <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">DEFLATION AND ECONOMIC POLICY <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Deflation can normally be controlled by an expansionary monetary policy with the Central Bank or the Government allowing the money supply to expand. This causes interest rates to fall and stimulates consumer spending and investment demand. Occasionally though, when prices are falling, lenders may call in loans or refuse to lend out to potential borrowers. This is known as a credit crunch. <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Cutting interest rates may not be sufficient during a credit crunch. In this case, expansionary fiscal policy (lower direct and indirect taxes and higher government spending) is often prescribed to cure deflation. <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">One reason deflation is difficult to cure is that nominal interest rates cannot fall below zero, while prices of goods and services can fall for a long time. In this event, monetary policy is unable to prevent higher real interest rates and the economy spirals downwards towards a slump caused by falling prices, contracting output, falling investment, plant closures and increasing levels of job losses in those industries affected.

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">"Deflation" is occurring in the markets for some goods in the UK economy. The annual rate of inflation for products such as textiles and audio-visual equipment has been negative for some time leading to cheaper prices for consumers and an increase in their real purchasing power.

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">[|What is wrong with deflation (Video)]

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<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Japanese Deflation

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Japan and deflation:

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;"> <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">home

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 20px;">Student extension task: <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Here is a link to a great simulation that you can play that allows you to manipulate interest rates in order to control inflation. I'll assign you groups and each week for the remainder of the term we'll spend time in class looking at how successful you have been. You'll need to meet up once a week for at least 40 minutes to decide upon your team's strategy <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">[|Monetary policy game]

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Note also that the website has a great site for students to independently research the effects of inflation and deflation on a country <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">(just click on [|inflation island] )

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">In Summary

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<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">And for HL students

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