Lecture_4

Lecture_4 - Lecture 4 Principles of Macroeconomics Econ 2...

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Lecture 4 Principles of Macroeconomics Econ 2 Winter, 2009
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Inflation and Interest Rates We have defined inflation as the percentage change in a price index between two periods So, what are the problems associated with inflation?
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Inflation
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Inflation Some problems Adds noise to the price system You learned in Econ 1 that prices convey information Scarcity, etc. Example, oil
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Oil Example As the price of oil rises: We demand less of it More fuel efficient cars Public transportation But, more will be supplied New oil fields drilled, etc. This is a change in the relative price
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Price Changes We learned last time that there is a distinction between all prices changing and a relative price change Why is it a problem, then, if all prices double?
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Inflation Adds noise to the price signal Makes it difficult to distinguish a change in relative prices from a change in the price level
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Inflation Some problems Adds noise to the price system Tax distortions
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Taxes The income tax system in the U.S. is: A) a value added tax system B) regressive tax system C) progressive tax system D) a flat tax system
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Taxes The income tax system in the U.S. is: C) progressive tax system
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Inflation and Taxes Tax distortions In the U.S., income taxes are progressive That is, people with higher incomes pay a higher percentage of their income in taxes
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Inflation and Taxes Tax distortions Note: Inflation means a general rise in prices—including the price of labor (wages) So, when all prices double, you can still buy the same stuff as before
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Inflation and Taxes Tax distortions If all prices rise, due to the progressivity of the tax system, you might go into a higher tax bracket— bracket creep However, income tax brackets are indexed to the CPI
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Inflation Some problems Adds noise to the price system Tax distortions Shoe-leather costs
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Inflation Shoe-leather costs When inflation is high keeping cash in your pocket is expensive Its purchasing power is eroding Therefore, must make more trips to the bank
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Hyperinflation Some countries, during some periods, experience very high inflation
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Israeli Inflation, 1985 In 1985 Israel experienced monthly inflation of approximately: A) 20 % B) 100 % C) 300 % D) 400 %
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Israeli Inflation, 1985 In 1985 Israel experienced inflation of approximately: A) 20 % B) 100 % C) 300 % D) 400 %
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This note was uploaded on 01/29/2010 for the course ECON 3A taught by Professor Loster during the Summer '07 term at UCSB.

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Lecture_4 - Lecture 4 Principles of Macroeconomics Econ 2...

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