Introduction

to Economics:
Social Issues
and Economic
Thinking

Wendy A .
Stock

CHAPTER 7
INFLATION AND THE PowerPoint
Prepared by
Z. Pan
MEASUREMENT OF PRICES
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 AFTER STUDYING THIS CHAPTER, YOU
SHOULD BE ABLE TO:

➢ Explain the difference ➢ Distinguish the

between the face value sources of inflation
of money and the ➢ Illustrate the
purchasing power of difference between
money real and nominal
➢ Describe inflation and values
calculate inflation
across time periods
➢ Describe the winners
and losers from
inflation

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 INFLATION

➢ Inflation is the rise in the general level of

prices in an economy.

➢ Zimbabwe’s hyperinflation
➢ Inflation rate 11.2 million percent per year
➢ prices doubled every 25 hours!

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 THE VALUE AND USES OF MONEY

➢ The Face Value of Money is determined by

governments and printed on currency.

➢The Purchasing Power of Money reflects the

amount of goods and services that a given
unit of money could be used to acquire.

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 DEFINITION OF MONEY

Three Roles of Money:

➢ Medium of Exchange – Money can be used as a
means of payment for goods and services or
repayment of debt.
➢ Unit of Account – Money provides a common
measure of the worth of goods or services.
➢ Store of Value – Money can be saved and used
to purchase goods and services at a future
time.

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 EVOLUTION OF MONEY

➢ Commodity Money has value for its own sake,

in addition to its value as money.
➢ e.g. gold, silver, shells, stones, decorated belts,
cigarettes, and alcohol

➢Fiat Money has value because of government

law or regulation.
➢ e.g. Federal Reserve Notes, most paper money

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 MEASURING PRICES AND INFLATION

➢ Price Index - A measure of the average prices

of a given set of goods or services across time.
➢ Consumer Price Index (CPI) is the ratio of the
cost of the market basket in one year over the
cost of the market basket in the base year
multiplied by 100.
➢ A Market Basket is a fixed set of goods or
services whose prices are tracked across time.

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 MEASURING PRICES AND INFLATION

Consumer Price Index (CPI) measures the cost of

the market basket in the current year as a
percentage of the cost of the same basket of
goods and services in the base year.

cost of market basket in current year

𝐶𝑃𝐼𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑦𝑒𝑎𝑟 = × 100
cost of market basket in base year

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 CALCULATING CPI: AN EXAMPLE

Three Steps:
1) Finding the prices in the market basket
2) Computing the cost of the market basket in each
year
3) Calculating CPI by taking the ratio

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 CALCULATING CPI: AN EXAMPLE

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 U.S. CONSUMER PRICE INDEX

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 INFLATION RATE

➢ Inflation Rate - The percentage change in the

price level over time. It is measured as the
percent change in the price index (PI) between
two periods.

𝑃𝐼2 −𝑃𝐼1
Inflation rate = × 100
𝑃𝐼1

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 CALCULATING INFLATION RATE – AN
EXAMPLE

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 U.S. INFLATION RATE (1950-2010)

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 DEFLATION AND DISINFLATION

Disinflation is a period of positive but falling

inflation. Disinflation indicates a slowing of the
rate of price increase in the economy.

Deflation is negative inflation. Deflation

indicates a period of declining prices of goods
and services.

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 WORLD INFLATION COMPARISON

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 SOURCES OF INFLATION

➢ Government printing too much money

➢ Demand Pull Inflation

➢ Cost Push Inflation

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 SOURCES OF INFLATION

Demand-pull Inflation arises from increases in

aggregate demand.

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 SOURCES OF INFLATION

Cost-push Inflation arises from decreases in

aggregate supply.

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MEASURING NOMINAL AND REAL VALUES

➢ Nominal Values are values that have not been

adjusted for inflation.

➢ Real Values are values that have been adjusted

for inflation.

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MEASURING NOMINAL AND REAL VALUES

An Example:
1960: CPI = 29.6
Your grandma's starting salary as a school teacher =
$6,500
2010: CPI = 220.2
Your starting salary as a school teacher = $45,000
Will you make more than she did in real earnings?

Copyright © 2013 John Wiley & Sons, Inc. 21

MEASURING NOMINAL AND REAL VALUES

➢ First, convert all nominal values into real values in

base year (base year = 1982 – 84)

Real value in base year = (nominal value in current

year/CPI in current year) x 100

➢ Then, compare

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MEASURING NOMINAL AND REAL VALUES

1960: CPI = 29.6

Your grandma's starting salary as school teacher =
$6,500
2010: CPI = 220.2
Your starting salary as a school teacher = $45,000
Grandma’s real salary = ($6,500/29.6) x 100 =
$21,959 in 1982–84 dollars.
Your real salary = ($45,000/220.2) x 100 = $20,436
in 1982–84 dollars.
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 QUESTIONS/DISCUSSIONS

During 2011, many citizens in the Middle

East called for governmental reform. In
some countries, oil production was
reduced in the face of protests. Use an
AD/AS diagram to illustrate the potential
impact of these outcomes on inflation in
the United States.

Copyright © 2013 John Wiley & Sons, Inc. 24

 KEY CONCEPTS

• Inflation
• Face value of money
• Purchasing power of money
• Medium of exchange
• Unit of account
• Store of value
• Commodity money
• Fiat money
• Price index
• Market basket
Copyright © 2013 John Wiley & Sons, Inc. 25