Inflation

Purchasing Power - Amount of goods and services that money buys. Ex. $2 dollars $1 in 1986

• General rising level of prices
• It reduces the "purchasing power" of money

1. Government prints too much money (The quantity theory)
2. Demand Pull inflation  (too many dollars chasing too few goods)
1. Demand pulls up prices!!! Demand increases but supply stays the same. The result is a shortage driving prices up.
3. Cost Push inflation (higher production costs increase prices) Ex. Gas during Hurricane Katrina.

• Ideal inflation rate: 2-3% Recession: decreases 2%

Formula: current year price index - base year price index /  base year price index X 100

• The Rule of 70
• Used to calculate the number of years it will take for the price level to double at any given rate of inflation.
• Formula: 70 / annual rate of inflation

• Deflation and Disinflation
• Deflation - decline in the general price level
• Disinflation - occurs when the inflation rate itself declines.

• Real interest rates
• It is the percentage increase in purchasing power that a borrower pays to the lender. (adjust for inflation)
• Formula: nominal interest rate - expected inflation

• Nominal interest rates
• Percentage increase in money that the borrower pays back to the lenders not adjusting for inflation.