Econ 104 1st Edition Lecture 12 Outline of Last Lecture I Calculating inflation rate II Purchasing power III Consequences of inflation IV Real vs Nominal Income V Inflation interest rates Outline of Current Lecture I Interest Rate II Unanticipated Inflation III Business Cycle Current Lecture I II III IV The interest rate is the a Cost of borrowing and the return to lending Real vs Nominal a Nominal interest rate i the stated interest rate on a loan saving account certicifate of deposit CD i Is observable b Real interest Rate i Is not obersavable c Expected interest rate i r expected inflation Unanticipated inflation is it better for the borrower or the saver a Borrower EXAMPLE Suppose in 2015 a Expected inflation is 0 b Unanticipated inflation is 10 actual expected c Lenders and savers lose i You inherit 10 000 at the end of 2015 1 You place in savings account at PNC for 1 year at 5 u These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute V VI a At the end of 2015 i 10 000X1 05 10 500 2 Case 1 Inflation 0 in 2015 a A the end of year you owe 10 000 X 1 05 10 500 3 Case 2 Inflation 10 in 2015 a Real Value of loan at the end of 2015 i 10 500 110 100 9545 b Purchasing power has declined d Borrrowers i Example ii PNC gives you a loan for 10000 at 5 interest u 1 Case 1 Inflation 0 in 2015 a A the end of year you owe 10 000 X 1 05 10 500 2 Case 2 Inflation 10 in 2015 a Real Value of loan at the end of 2015 i 10 500 110 100 9545 Summary a Interest rate shrinks income as interest rises real income falls i Inflation hurts when it is unexpected b Base year CPI is always 100 c Nominal interest rates can never be negative d Real interest rates can be positive or negative i Negative when inflation is rising e When r 0 lenders and savers both lose i Interest earnings do not keep up with inflation f When r 0 borrowers win i They pay back less than real terms g Conclude i r 0 1 You are more likely to spend ii r 0 1 You are more likely to save Business Cycle a Alternating periods of economic growth and contraction which can be measured in changes in real GDP b Has four cycles i Expansion 1 Production employment and income are increasing Spending by firms and households increases ii Peak 1 the expansion ends iii Recession 1 Production employment and income are decreasing Spending by firms and households decreases iv Trough 1 The recession ends c One Cycle Peak to peak
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