Causes and Effects of Different Types of Inflation

1. Inflation- rise in the general price level
2. Deflation- a decline in the general price level
3. Disinflation- occurs when the inflation rate itself declines

Solving inflation problems: 

• Rule of 70 determines how many years it will take to double inflation

          Take 70 and divide it over the annual inflation rate

• Inflation Rate

          (Current year - Prior year) / (Old price index) x 100
          2-3% inflation = good

• Finding real interest rates (cost of borrowing/lending money that is adjusted for expected inflation)

          Nominal interest rate (unadjusted cost of borrowing/lending money)  - Inflation = (%)

Causes of Inflation

• Demand Pull: caused by an excess of demand over output that pulls prices upward

          -Output and employment rise while the price level is also rising
          -Spending increases faster than production
          -Increase in government purchases
          -Excessive increase in price of supply
              *Hyper inflation- rapid rise in the inflation rate
          -Rising incomes as the economy approaches full employment

• Cost Push: (supply side of economy) caused by a rise in per unit production costs due to increased resource costs

          -Supply shocks: dramatic rise in energy/raw material prices due to input shortages or growing demand for inputs
          -Price wage spiral: workers seek higher wages to offset rising consumer prices

Effects of Inflation

• Anticipated vs. Unanticipated 

          -Unanticipated has stronger effects because those expecting inflation may be able to adjust work/spending habits to lessen the effects
          -wage and pension may have cost of living adjustment (COLA) built in to offset anticipated inflation
              *Fixed income people=hurt because their real income suffer (nominal income doesn't rise with prices)
              *Savers=hurt by unanticipated inflation because inflation takes away from the interest earned on the account
              *Borrowers can be helped because the debt would be prepaid with cheaper dollars than loaned out
              *Lenders=hurt because borrowers would repay them with cheaper dollars than the ones loaned out