Economics

Confusion over Inflation

Inflation can cause three types of problems:

• Blurred price signals
• Unintended redistributions of purchasing power
• Difficulties in long-term planning

Unintended Redistributions of Purchasing Power

• People who are hurt by inflation include those who are holding a lot of cash
• When inflation happens, the buying power of cash is diminished
• Cash is only an example of a more general problem: anyone who has financial assets invested in a way that the nominal return does not keep up with inflation will tend to suffer from inflation

Benefits of Low Inflation

• An annual inflation rate of 2%, 3%, or 4% is a long way from a national crisis
• If variability in inflation rates is a problem, then moderate and high inflations are more likely to have significant variability than are low inflations
• Low inflation is also better than deflation which occurs with severe recessions
• Moderate inflation may help the economy by making wages in labor markets more flexible

Quick Review

• Define and differentiate between employed, unemployed, and being in or out of the labor force
• How do you calculate labor force percentages and the unemployment rate?
• Explain historical patterns and trends of unemployment in the U.S
• Evaluate global unemployment rates
• What is cyclical unemployment?
• What is the relationship between sticky wages and employment using various economic arguments?
• What is frictional unemployment and structural unemployment?
• What is natural unemployment?
• What is the relationships between the natural rate of employment and potential real GDP, productivity, and public policy.

More Quick Review

• What is an example of inflation? Explain
• What is a price index is? How do you compute one?
• How do you calculate inflation rates using price indices?
• Using Consumer Price Index (CPI), how do you calculate U.S. inflation rates
• What are the major shortcomings of the CPI as a measure of the cost of living?
• Explain how the substitution bias and the quality improvement/new goods bias causes the CPI to overstate the cost of living
• Contrast the CPI with other price indices, including the PPI and GDP Deflator

More More Quick Review

• What are the ways inflation can blur the perception of supply and demand?
• How can inflation cause redistributions of purchasing power
• Explain the possible economic benefits of inflation