Econ: Inflation


Inflation is the increase in the general level of prices. The Consumer Price Index measures the prices of a market basket of goods purchased by the typical urban consumer. Demand-pull inflation is caused by an increase in demand (often due to an increase in the money supply) beyond the ability of firms to supply products. Cost-push inflation results from an increase in the cost of production, which causes firms to reduce supply and raise prices.

Inflation affects consumers by reducing the value of the dollar. Nominal income is the wage in current dollars, while real income removes the effects of inflation, measuring the value of what the paycheck will actually buy in the economy. Unanticipated inflation harms people on fixed incomes because they cannot buy as much with the same income. Savers are hurt because the real value of their savings declines. Creditors are hurt because the money repaid does not have the same purchasing power as the money that was originally loaned. Those who have cost-of-living adjustments (COLAs) in their salaries are unaffected by inflation, because their salaries increase with the rate of inflation, holding their purchasing power steady. Borrowers actually win from inflation, because they repay their debts with dollars that hold less value than the dollars they borrowed. Workers try to anticipate inflation by seeking COLAs or pay increases that match or exceed the inflation rate. Banks and other creditors anticipate inflation by adding the expected rate of inflation to the real interest rate, to determine the nominal interest rate they will charge their customers for loans.



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