Unit 2: Inflation

Inflation

• Reduces the purchasing power of money. 
• When inflation occurs each dollar of income will buy fewer goods than ever before. 

3 Causes of Inflation:

1. The government prints too much money. 
2. Demand- pull inflation: Too many dollars chasing too few goods. Demand pulls up prices. 
3. Cost- Push inflation: High production costs that increases prices. 

Unanticipated inflation:

• Hurt by inflation: Lenders (money loaned out is at a fixed rate); People who are on a fixed income; Savers  
• Helped by inflation: The borrowers; a business where the price of the product increases faster than the price of resources; flexible income people. 
• Unaffected or uncertain by inflation: Arm (an adjustable rate mortgage), People who have: a salary, a pension or social security that receives a cola (cost of living adjustment). 

Nominal interest rate: the unadjusted cost of borrowing or lending money.

Real interest rate: the cost of borrowing or lending money which is adjusted for inflation.

Real interest formula: (Nominal interest rate)-(Inflation)