econ 6 - Dr Mohammed Alwosabi ECON 141 Ch.6 Notes on...

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Dr. Mohammed Alwosabi ECON 141- Ch.6 1 Notes on Chapter 6 INFLATION DEFINITION OF INFLATION ± Inflation is a process of continuous (persistent) increase in the price level. Inflation results in a decrease of the value of money. ± In the definition of inflation we have to observe that: o Inflation is an increase in the prices of all goods and services not only of a particular good or service. An increase in the price of one good is not inflation. o Inflation is an ongoing process, not a one-time jump in the price level. INFLATION RATE: ± To measure the inflation rate, we calculate the annual percentage change in the price level. 100 P P - P Rate Inflation year last year last year this × = ± We have learned that we measure the price level (P) of a country using GDP Deflator or CPI. 100 Deflator GDP Deflator GDP - Deflator GDP Rate Inflation year last year last year this × = OR 100 CPI CPI - CPI Rate Inflation year last year last year this × = ± These two equations show the connection between the inflation rate and the price level. If the price level in the current year is
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Dr. Mohammed Alwosabi ECON 141- Ch.6 2 higher than that of the last year, the inflation rate will be positive meaning higher inflation rate Ö the lower is the value of money. CAUSES OF INFLATION ± The inflation can result from either 1. an increase in aggregate demand (demand-pull inflation), or 2. a decrease in aggregate supply (cost-push inflation) Demand-Pull Inflation ± Demand-pull inflation as a result of the increase in spending is faster than the increase in production of output. ± Demand-pull inflation starts as AD increases and AD curve shifts rightward. ± An increase in aggregate demand is caused mainly by 1. the increase in quantity of money (Q m ), 2. the increase in any of C, I, G, or X The Process of Demand-Pull Inflation ± Suppose in the last year, the economy is at LR full employment equilibrium point A, where LAS, AD 0 and SAS 0 intersect with each other. ± At this point, RGDP = PGDP and P = P 0 . ± In the current year, an increase in Q m , C, I, G, or X leads to an increase in AD AD curve shifts rightward from AD 0 to AD 1 the new SR equilibrium is at point B, ± At B, RGDP is greater than PGDP, price level increases from P 0 to P 1 , real wage rate has decreased and unemployment falls below its natural rate (above FE) there is a shortage of labor money P 0 P 1 P 2 RGDP P AD 0 LAS SAS 0 SAS 1 AD 1 Y 0 Y 1 A B C
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Dr. Mohammed Alwosabi
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This note was uploaded on 04/06/2010 for the course BUSINESS econ, taught by Professor Mohammed during the Spring '10 term at École Normale Supérieure.

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econ 6 - Dr Mohammed Alwosabi ECON 141 Ch.6 Notes on...

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