Lesson 1: Costs of Inflation
Learning Objective: I can explain the concepts of inflation, disinflation, and deflation.
PRICE STABILITY!
Inflation: Persistent increase in the average price level in the economy, usually measured through the calcuation of CPI (consumer price index).
Costs of Inflation:
1. Loss of purchasing power
Delfation: Persistent fall in the average level of prices in the economy... Both good and bad.
1. Good deflation
Costs of Inflation:
1. Loss of purchasing power
- Inflation is at 2%, if your income remains constant then you will not be able to buy as many goods/services. Fall is real income.
- Inflation reduces purchasing power of incomes.
- If you save $1,000 in the bank at 4%, then you will have $1,040. But if inflation is 6%, then the real rate of interest will be negative and your savings should have been used for consumption.
- Inflation discourages savings... Fixed assets are a common alternative, but this comes with negative consequences.
- Banks rely interest so to keep the real rate they earn positive, interest rates increase.
- If a country has a higher rate of inflation than that of its trading partners then exports are less competitive. This may lead to fewer export revenues, greater expenditure on imports, thus worsening the trade balance... Also may lead to unemployment.
- Firms may be discouraged from investing due to the uncertainty associated with inflation... Negative growth :(
Delfation: Persistent fall in the average level of prices in the economy... Both good and bad.
1. Good deflation
- Improvements in the supply side of the economy, increased productivity.
- Demand side... what can be attributed to this scenario?
Costs of deflation:
1. Unemployment
- AD is low then businesses are likely to lay off workers.
- Consumers will put off the purchase of any durable goods as they will want to wait until prices drop even further (deferred consumption).
- Consumer confidence will fall.
- Businesses make less profit or loses, this may lead to unemployment.
- Low business confidence may likely result in reduced investment.
- Value of debt rises...
Activity: Illustrate a political cartoon depicting a consequence of inflation or deflation.