Inflation & Deflation

Reference 13.1 and 13.2

 Aggregate=all together
• Aggregate demand and aggregate supply
considers the entire quantity of goods and
services in an economy.
• The equilibrium price in aggregate supply
and demand curves is called the price level.

D1 S1

Q
 Inflation / Deflation
What is it?
an increase in the price level
a decrease in price level
How is it determined? CPI= Consumer Price Index

by comparing the CPI in different years and

noting the change
CPI is higher=inflation
CPI is lower=deflation
• Last year’s CPI (based on 1984 prices)
$216.17
• This year’s CPI
$218.70
• Inflation rate
3.82%
Can be caused by
supply-side shifts or demand-side shifts
woohoo!!
• Under what conditions would you expect more people!!
more money!!
to see inflation (rise in price level)?
Inflation can be caused by an increase in aggregate demand

Inflation can be caused by a decrease in aggregate supply

o
gr il
ain

• Under what conditions would you expect

to see deflation (fall in price level)?
Deflation can be caused by a decrease in aggregate demand
Deflation can be caused by an increase in aggregate supply
 Simple Quantity Theory of Money
• If velocity and quantity of output (supply)
are constant, more money in circulation
leads to higher prices.

What does velocity mean?

velocity=the average number of times per year

a dollar is spent to buy final goods
 Simple Quantity Theory of Money
• If velocity and quantity of output (supply)
are constant, more money in circulation
leads to higher prices.

MxV=PxQ
M = money supply
V = velocity
P = price level % change M = % change P
Q = quantity of output
Inflation Rates between 1952 and
2008
• Low levels of unemployment are
frequently periods of higher inflation

More working people

with
more money

(increase in aggregate demand)

 remember Monetary Policy?
• The goal is to maintain price stability and
low unemployment.
 Monetary Policy
• Fed is responsible for maintaining price
stability and employment
• “Expansionary Monetary Policy”
– goal is to increase money supply
• to reduce unemployment
• to avoid deflation
• “Contractionary Monetary Policy”
– goal is to decrease the money supply
• to reduce inflation
 So What?
• Negative Effects of Inflation
– hurts people on fixed incomes (the retired)
– hurts savers
– hurts lenders (helps debtors)
– hurts people who contract to be paid in the future
– makes financial decision making more difficult
• hedging = avoiding or lessening a loss by taking a
counterbalancing action.
– buy gold or some other store of value besides money
 So What?
• Negative Effects of Deflation
– Great Depression!
– uneven fall in prices
• business failures
• job loss
– hurts debtors
– hurts property-owners
 Stagflation
What’s up with that?

• stagnant (persistently high) unemployment

and
• inflation

1970’s US and other industrialized nations experienced stagflation

• erratic monetary policy: stop-and-go, on-and-off
• supply shocks (OPEC)
 Review
• What are some possible causes of
inflation?
• What are some possible causes of
deflation?
• Why is the relationship between
unemployment and inflation usually
inverse?
• Why is inflation a problem?
 Review
• How does the “the fed” use monetary
policy to control inflation?
 Homework
• Read Chapter 14 Business Cycles and
Economic Growth pps. 364-386
– Complete Review Sections p.386-387
• Economics Vocabulary (writing complete sentences)
• Review Questions
• Analyzing Primary Sources

– Be prepared to take a chapter quiz

 Today’s Exit Pass
• In a small group, read 13.3
“Unemployment”
• Section Review p. 359
• #1 Definitions
• #2-3 (complete sentences)