Economics / Unit 8: Measuring the Economy: GDP, Unemployment and Inflation
8.6 Causes and Effects of Inflation
Notes
- Demand-pull inflation: total spending grows faster than the economy can produce, "too much money chasing too few goods."
- Cost-push inflation: rising costs of inputs, such as oil or wages, push prices up.
- The quantity theory of money holds that if the money supply grows much faster than output, prices rise.
- Inflation reduces purchasing power: each dollar buys less. People on fixed incomes and savers earning low interest are hurt. Borrowers who repay fixed-rate loans with cheaper dollars can benefit, while lenders lose.
- Real interest rate $=$ nominal interest rate $-$ inflation rate. A $6\%$ loan during $4\%$ inflation has a real rate of about $2\%$.
- A real wage adjusts pay for inflation. A $3\%$ raise during $5\%$ inflation is about a $2\%$ cut in real terms.
- Hyperinflation is extremely rapid inflation, as in Germany in 1923 and Zimbabwe in the late 2000s. Stagflation, high inflation with high unemployment, hit the U.S. in the 1970s.
Practice
Shira earns a $4\%$ raise in a year when inflation is $6\%$. What happened to her real wage?
Her pay rose less than prices, so her purchasing power fell by about $6\% - 4\% = 2\%$.
A bank charges $7\%$ on a loan while inflation is $3\%$. The real interest rate is about:
Real rate $\approx 7\% - 3\% = 4\%$.
A sharp rise in oil prices raises the cost of making and shipping many goods, and prices rise across the economy. This is:
Higher input costs push prices up from the supply side.
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