Definition: Inflation is a rising general level of prices (not all prices rise at the same rate, and some

may fall). Consumer price index (CPI) The main index used to measure inflation is the Consumer Price Index (CPI). CPI = (Price of the Most Recent Market Basket in the Particular Year)/(Price estimate of the Market Basket in 2010-2011) *100 Market basket 300 goods and services Typical urban consumer 2 year updates

To measure inflation, subtract last year's price index from this year's price index and divide by last year's index; then multiply by 100 to express as a percentage. The CPI was 207.3 in 2010, up from 201.6 in 2009, thus, Rate of inflation = 207.3 201.6/201.6 * 100 = 2.8%

Period 1991-1992

SPI 10.54

CPI 10.58

WPI 9.84

1992-1993
1993-1994 1994-1995 1995-1996 1996-1997 1997-1998 1998-1999 1999-2000 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005 2005-2006 2006-2007

10.71
11.79 15.01 10.71 12.45 7.35 6.44 1.83 4.84 3.37 3.58 6.83 11.55 7.02 10.82

9.83
11.27 13.02 10.79 11.80 7.81 5.74 3.58 4.41 3.54 3.10 4.57 9.28 7.92 7.77

7.36
11.40 16.00 11.10 13.01 6.58 6.35 1.77 6.21 2.08 5.57 7.91 6.75 10.10 6.94

Rule of 70 permits quick calculation of the time it takes the price level to double: Divide 70 by the percentage rate of inflation and the result is the approximate number of years for the price level to double. If the inflation rate is 7 percent, then it will take about 10 (=70/7) ten years for prices to double.

In the past, deflation has been as much a problem as inflation. For example, the 1930s depression was a period of declining prices and wages. The prospect of deflation was a concern of economic policymakers earlier this decade. All industrial nations have experienced the problem Some nations experience enormous rates of inflation Zimbabwe's was 585 percent in 2005.

Types of Inflation Demand pull, Cost-push Demand pull inflation Spending increases faster than production. It is often described as too much spending chasing too few goods. as the increased money supply caused inflation and reduced the purchasing power of each dollar. It could be caused by an over-issuance of money by the central bank.

Prices rise because of rise in per-unit production costs per-unit production costs =total input cost units of output Output and employment decline while the price level is rising. Supply shocks have been the major source of cost-push inflation. These typically occur with dramatic increases in the price of raw materials or energy. e.g., in the mid-1970's, output and employment were both declining while the general price level was rising. Rising per-unit production costs squeeze profits and reduce the amount of output firms are willing to supply. The economy's supply of goods and services declines and the price level rises.

It is difficult to distinguish between demand pull and cost push causes of inflation, e.g., a significant increase in total spending occurs in a fully employed economy, causing demand-pull inflation. This stimulus works its way through various product and resource markets, individual firms and their wage costs, material costs, and fuel prices rising. It may appear to be cost-push inflation to business firms and to government. Demand-pull inflation will continue as long as there is excess total spending. cost-push inflation is automatically self-limiting, it will die out by itself. Demand-pull inflation will continue as long as there is excess total spending. Generates a recession which makes households and businesses concentrate on keeping their resources employed, not on pushing up the prices of those resources.

Inflation redistributes real income. This redistribution helps some people, hurts some others, and leaves many people largely unaffected. Nominal and real income Nominal income is the number of dollars received as wages, rent, interest, or profits. Real income is income adjusted for inflation. i.e. Real income = Nominal income/price index The price index is used to deflate nominal income into real income. Inflation may reduce the real income of individuals in the economy, but won't necessarily reduce real income for the economy as a whole (someone receives the higher prices that people are paying).

%age change in real income=%age change in nominal income%age change in price level

Anticipated vs. unanticipated inflation Unanticipated inflation has stronger impacts; those expecting inflation may be able to adjust their work or spending activities to avoid or lessen the effects.

Fixed-income receivers Fixed income groups will be hurt because their real income users. Their nominal income does not rise with prices. Savers Savers will be hurt by unanticipated inflation, because interest rate returns may not cover the cost of inflation. Their savings will lose purchasing power. Creditors

Flexible-income receivers Cost-of-living adjustments (COLAs) Debtors Debtors (borrowers) can be helped and lenders hurt by unanticipated inflation. Interest payments may be less than the inflation rate, so borrowers receive dear money and are paying back cheap dollars that have less purchasing power for the lender.

If inflation is anticipated, the effects of inflation may be less severe, since wage and pension contracts may have inflation clauses built in, and interest rates will be high enough to cover the cost of inflation to savers and lenders. e.g., the prolonged inflation that began in the late 1960s prompted many labor unions in the 1970s to insist on labor contracts with cost-of-living adjustment clauses.

Deflation Unexpected deflation, a decline in price level, will have the opposite effect of unexpected inflation. People with fixed nominal incomes will find their real incomes enhanced. Creditors will benefit at the expense of debtors. Savers will discover their purchasing power grows. Mixed effects Many families are simultaneously helped and hurt by inflation because they are both borrowers and earners and savers. Arbitrariness Effects of inflation are arbitrary, regardless of society's goals.

Inflation affect an economy's level of real output. And thus its level of real income. Cost-push inflation and real output Cost push inflation, where resource prices rise unexpectedly, could cause both output and employment to decline. Real income falls. e.g., in late 1973, OPEC quadruple the price of oil. This generated rapid price-level increases in the 1973-1975 period, and the U.S. unemployment rate rose from 5% in 1973 to 8.5% in 1975.

Mild inflation (< 3%) has uncertain effects. It may be a healthy by-product of a prosperous economy, or it may have an undesirable impact on real income. Defenders of mild inflation say that it is much better for an economy to err on the side of strong spending, full employment, economic growth, and mild inflation than on the side of weak spending, unemployment, recession, and deflation.

Danger of creeping inflation turning into hyperinflation, which can cause speculation, reckless spending, and more inflation. Japan following World War II, and Germany following World War I.