INFLATION: increase in average level of prices, not change in any specific price of a good market
function.
Effects of Inflation
1) Price
–+
Those who MUST buy products that are
increasing in price the fastest end up worse
off.
Those who MUST sell products that are
increasing in price the slowest end up worse
off.
Those who CAN sell products that are
increasing in price the fastest end up better
off.
Those who can buy products that are
increasing in price the slowest end up better
off.
2) Income
NOMINAL INCOME: amount of money income received in a given time period, measured in
current dollars.
REAL INCOME: income in constant dollars, nominal income adjusted for inflation.
–+
People with fix nominal incomes end up
worse off (salaries)
People with flexible nominal incomes end up
better off
3) Wealth
–+
Those who own assets that are declining in
real value end up worse off (savings, credits)
Those who own assets that are increasing in
real value end up better off (housing)
Macro Consequences of Inflation
oUNCERTAINTY – not knowing prices of goods in future makes purchasing & production
decision making much more difficult.
oSPECULATION – decisions will shift from standard economic activity to betting on future
prices of goods ( that is because people react based on incentives).
oBRACKET CREEP – in a progressive tax system, when nominal incomes rise, taxpayer gets
pushed into a higher tax bracket.
HYPERINFLATION: inflation rate in excess of 200 percent, lasting at least 1 year.
Spending accelerates and production declines
