Econ 201 - Inflation in America

Inflation in America

Econ 201

With such drastic changes in the economy, we have to wonder if inflation is necessary and what are the negative and positive effects it has on our everyday life. Within this paper we will discuss the different forms of inflation to include, spiraling inflation, cost push inflation and demand pull inflation. We will also discuss how inflation affects the growth of the economy in areas such as standards of living, retirement income and interest rates. We will finish our discussing with the negative and positive effects of inflation and where we stand in America right now.

Inflation according to our Macroeconomics book by Hubbard and O'Brien is the percentage increase in the average level of prices from one year to the next. High inflation rates are anything over 3 or 4 percent. We strive to keep inflation low because this means the cost of goods in not rising faster than an individual's paycheck. As prices rise, currency will purchase fewer goods and services. Inflation also deletes the purchasing power of currency. The goal of the Federal Reserve is to maintain inflation that is steady, anything other than steady inflation creates an uncertainty in the market. In America our current inflation rate as of February 2011 is 2.1% up 0.5% from January 2011. The rise in inflation is focused around the uncertainty in the Middle East and rising oil prices. Often when we see a rise in oil prices we see a spike in other commodities as well.

Most people think that inflation is evil, however, this isn't necessarily so. Inflation affects people in different ways and it also depends on if it in anticipate or unanticipated inflation. Anticipated is when the rates correspond to what most people were expecting (anticipated). Anticipating the inflation rates allows individuals and banks to prepare and workers to negotiate their contracts based off what is anticipated. Unanticipated inflation is not such a good thing, it makes it so corporations and consumers are less likely to spend and it also makes it so the purchasing power of individuals that are on a fixed income declines which also decreases their standard of living. There are two ways to measure inflation. The first is the Consumer Price Index (CPI), which is the measure in the price change of goods and services. These good and services include gasoline, food, clothing and automobiles. The Producer Price Index (PPI) is the average change overtime of prices by domestic producers of goods and services.

Spiraling inflation is the worst kind of inflation, it is generally known as runway inflation. When the economy is experiencing spiraling inflation there is raising cost which affects a rise in prices which cause a rise in the price of production. 1973-1975 was the last time that America experienced spiraling inflation. The inflationary spiraling effect was a result of tensions between Organization of Arab Petroleum Exporting Countries (OPSEC) and the United States. The catalyst to the inflation of oil between the West and Middle East was the United States support towards Israel. During this time the price of gas rose from 30 cents per gallon to $1.20 per gallon. Then President Nixon enforced gas stations to ration gas at 10 gallons per customer. This was a rough time for many Americans, most lived in rural areas and had to drive to their place of employment. Due to the increase in oil there was a spiraling effect on the increase of other goods and services. Many businesses were forced to shut down due to rising cost. At the beginning of the embargo unemployment was at 4.9%, by the end it had raised to an all time high of 8.7%. Today many question whether America will experience another round of spiraling inflation. Most blame this on the Federal Reserve just printing money out of thin air and the rise in oil prices.

Cost-push inflation means that prices have been pushed up by the increase in the cost of any of the four factors of production which include: labor, capital, land or entrepreneurship. This most often occurs when companies are already running at full production capacity. When there are higher production costs and when productivity is maximized, companies cannot maintain profit margins by producing the same amounts of goods and services. As a result, the increased costs are passed on to consumers, causing a rise in the general price level. Production cost most often goes up due to several factors. Such factors could include that the employees are demanding pay increases. In order to offset this demand, companies will increase the price of products to consumers. Below is will aid in the visualization of how cost push inflation works. As production cost increases, supply decreases causing an increase in the price of the product.

Price

S2

P1 S1

P2

Q2 Q1 Output

Demand pull is our final type of inflation that we will highlight. Demand-pull inflation occurs if there are increases in aggregate demand. This can be categorized by four areas of the macroeconomy, these four sections include: households, businesses, governments and foreign buyers. When these four areas want to purchase more output than the economy can produce at the same time, they compete to purchase limited amounts of goods and services. Buyers in reality bid prices up causing inflation. Demand pull is also referred as too much money chasing too few goods which usually occurs in an expanding economy. There are many factors that cause demand pull inflation. These factors include increases in government purchase, deprecation in exchange rate which cause an increase in the price of imports reducing the price of exports. The overall result of this is that fewer imports will be purchased and exports will be increased. Another result of demand pull inflation is when the government puts money back in to the hand of consumers. This causes an increase in the demand which will cause demand pull inflation. The graph below show what effects demand has on supply and the price of items based off that supply, as demand increases, the cost to produce those good increase.