Week Four. Inflation

Transcription

1 Week Four Linus Yamane Inflation Inflation is NOT High prices Low income Obscene profits Oil company rip offs Inflation is when the general level of prices is rising Deflation is when the general level of prices is falling 1

2 Inflation Rate 100 :, Consumer Price Index (CPI) Weighted average of consumer good & services prices Producer Price Index (PPI) Wholesale or producer prices 3,400 commodities (food, manufactured products, mining products) GDP Deflator Price of everything in GDP (C,I,G,NX) Variable weight index Consumer Price Index Fixed expenditure weights Weighted by economic importance Weights are expenditures in Sample of 71,000 goods and services, 22,000 establishments, 44 geographic regions,,,

3 Consumer Price Index Year CPI Inflation Year CPI Inflation Problems Measures cost of living (not production) Does not account for quality changes Counts tax increases as price increases New technological goods introduced after long lag Fixed expenditure weights Uses list prices, not market prices Not representative of all consumers 3

4 Consumer Price Index Item Budget Item Budget share share Housing 41.5% Communication 3.3% Transportation 17.3 Education 3.1 Food 14.8 Other 3.5 Medical Care 6.6 Recreation 6.3 College tuition 1.5% The average American family has an income of $50,000, consumes about $45,000, and spends about $675 on college tuition and fees. Types of Inflation Moderate Inflation Less than 10% annually People trust money People write contracts in nominal terms Galloping Inflation Double or triple digit inflation Most contracts become indexed to a price index or a foreign currency Financial markets wither away People hoard goods Hyperinflation Inflation over 1000% a year Velocity of money rises Relative prices become very unstable Destroys the wealth of the rich 4

5 Famous Hyperinflations U.S. Confederacy 1860s Germany Bolivia Peru Brazil Poland Argentina Zaire (Congo) Angola Zimbabwe Zimbabwe Hyperinflation Start Date: March 2007 End Date: November 2008 Peak Month: November 2008 Inflation Rate: 7.96 billion percent April 2009: Use foreign currencies Date of redenomination Currency code Value 1 August 2006 ZWN ZWD 1 August 2008 ZWR 2 February 2009 ZWL ZWN = ZWD ZWR = ZWN = ZWD 5

6 Sources of Inflation Demand pull inflation 1960s Vietnam war Cost push inflation 1970s Oil shocks Inertial inflation Expectation of inflation Inflation is always and everywhere a monetary phenomenon Milton Friedman Quantity Equation of Exchange MV = PY Quantity Theory of Money MV = PY M = money supply V = velocity of money P = price level Y = real GDP The velocity of money is the number of times the stock of money turns over during the course of a year 6

7 Neutrality of Money Money is neutral when changes in the money supply lead only to changes in the price level, with no real variables (output, employment, real interest rates) changing. If you double the money supply, the price level should double. When wages double and prices double, nothing real has changed. Economic behavior should not change. Costs of Inflation Actual inflation = expected inflation + unexpected inflation Expected Inflation Efficiency loss Menu costs Shoe leather costs Unexpected Inflation Redistribution of wealth Winners Losers Uncertainty Reduces efficiency of the price system 7

8 90 Rip Off Rate 80 Rip Off Percent Why do people care about inflation? Inflation rate nominal wage increase 2% 4% 6% 8% 10% 12% 14% inflation rate 0% 2% 4% 6% 8% 10% 12% real wage increase 2% 2% 2% 2% 2% 2% 2% rip off percent 0.0% 50.0% 66.7% 75.0% 80.0% 83.3% 85.7% Long Run Growth Year Real GDP (bill ) Real GDP per capita Population (thousand) 1900 $466 $6,121 76, ,391 47, , ,802 53, ,373 Period Real GDP growth Real GDP PC growth Population growth % 2.07% 1.32% % 0.87% 0.88% 8

9 Long Run Growth Rates How long have we been growing at these rates? If real GDP per capita grows at 2.07% a year, real GDP PC grows by a multiple of 7.6 every 100 years. Year GDP PC 2000 $47, , ? 40,000 Real GDP Per Capita 35,000 30,000 25,000 Real 1996 Dollars 20,000 15,000 10,000 5, Year 9

10 11 Ln Real Per Capita GDP Ln Real 1996 $ Year Industrial Revolution Extensive Growth Most growth before the Industrial Revolution Linear replication of the economy Increasing the scale of the economy Intensive Growth Most growth after the Industrial Revolution Technological change Improvements in efficiency or productivity through innovation and economies of scale 10

11 Production Function GDP is a function of labor, capital, land, raw materials, and technology,, Y = GDP A: level of technology (research and development, inventions and innovations, learning by doing) Labor: skill level, education, population Capital : plant and equipment, residential structures, inventories Land : natural resources GDP Growth GDP increases over time because Growth in employment Increase in capital stock Increase in human capital Technological change Per Capita GDP increases over time because Growth in employment relative to the population Increase in capital stock Increase in human capital Technological change 11

12 Opportunity Cost of Economic Growth Worker s time and leisure Sacrifice of other social goals Consumption costs More investment means less consumption Budgetary costs Tax cuts or government spending increases require Raising other taxes Cutting other government spending Running budget deficits Aggregate Expenditure and Equilibrium Output 12

13 Y = C + I + G + NX GDP = Consumption + Investment + Government Spending + Net Exports (Exports Imports) Look at components of GDP more carefully Build an economic model of GDP determination Understand GDP by understanding the components of GDP Consumption Household purchases of goods and services Durables Goods (cars, furniture, vacuum cleaners ) $1, % 11% of consump on Nondurable Goods (food, clothing ) $2, % 23% of consump on Services (housing, healthcare ) $7, % 66% of consumption (#1 since 1954) Consumption is 68% of GDP $11,653.1 billion (2013 IV) 13

14 Keynesian Consumption Theory Consumption Disposable income (Yd) = Income (Y) taxes(t) Higher disposable income higher consump on Very poor are unable to save Draw down wealth or borrow Rich people save proportionately more of their income Savings = disposable income consumption Consumption Function Shows the relationship between consumption and disposable income C = f(yd) = a + byd a is the intercept, autonomous consumption, the amount of consumption you do independent of your income b is the slope, the marginal propensity to consume (MPC), the extra amount that you consume when you receive an extra dollar of income 14

15 MPC and APC Y C S $21,000 $21,200 $ ,000 22, ,000 22, Average Propensity to Consume (APC) Tends to fall as income rises Savings Function Shows the relationship between savings and disposable income Y = C + S C = a + by S = Y C S = Y (a + by) S = a + Y by S = a + (1 b)y 15

16 MPS Marginal propensity to save (MPS) The extra amount that people save when they receive an extra dollar of income Slope of the savings function NOTE: MPC + MPS = 1 since Y = C + S APS Average propensity to save (APS) 1 Tends to rise with income U.S IV billions Personal Income $14,295.6 Net Taxes $1,681.5 Personal Disposable Income $12,614.1 Consumption $12,069.0 Savings $ NOTE: APC + APS = 1 16

17 Consumption Function The consumption function is a fundamental Keynesian idea Consumption depends on disposable income If disposable income rises, consumption rises Ex. C = Yd If disposable income rises by $1, consumption rises by 80 here MPC = 0.80 Why do people save? Consumption In the short run, people save and dissave C Y In the long run, people don t save C Y The consumption puzzle In the short run, APC falls with income. Why? In the long run, APC is constant. Why? 17

18 Consumption Permanent Income Hypothesis Milton Friedman People save for a rainy day Poor are having a bad year Life Cycle Hypothesis Franco Modigliani People save for retirement Poor are the young and old Relative Income Hypothesis James Dusenberry People try to keep up with the Jones Poor have relatively low incomes Consumption depends on Disposable Income Expected Future Income Permanent income Wealth stock market, bond market, housing prices Distribution of Income Real Interest Rates Nominal Interest Rate Inflation Social Security 18