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Unformatted text preview: What is inflation? Inflation/Deflation- When the average price level of goods and services goes up or down. Relative Prices- The change in price of one good relative to another which signals to the market to change the price or output. Money Illusion- The use of nominal dollars rather then real dollars to estimate changes in wealth. (Ex. If prices and income rise by the same amount but people feel like theyre worse off. What are the redistributive effects of inflation (3)? Effects of Inflation 1. Price Effect and Redistribution- If prices rise and you buy it for your business, youre worse off whereas if prices go down and you buy it, youre better off. 2. Income Effect- If real income declines, it has different effects for different people. For example, people on a fixed income such as retirees or those on welfare are worse off but people on a non fixed income such as COLAs (Cost of Living Adjustments) are fine because inflation is built into their salary. 3. Interest Rate Effect- Also known as the Wealth Effect. Its how inflation affects savings. When real interest = nominal inflation. 0% = 3% - 3% 2% = 5% - 3% Inflation hurts savers and helps debts Other consequences of inflation include 1. Uncertainty 2. Speculation and hyperinflation 3. Bracket creep How is inflation measured? Measuring Inflation 1. CPI- Consumer Price Effect is a fixed basket of goods. (Ex. 100 in a base period) 2. PPI- Producers Price Effect is three different measures of producers prices. It yields the same results as CPI in the long run....
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