DOC PREVIEW
UGA ECON 2105 - Module 14
Type Lecture Note
Pages 5

This preview shows page 1-2 out of 5 pages.

Save
View full document
View full document
Premium Document
Do you want full access? Go Premium and unlock all 5 pages.
Access to all documents
Download any document
Ad free experience
View full document
Premium Document
Do you want full access? Go Premium and unlock all 5 pages.
Access to all documents
Download any document
Ad free experience
Premium Document
Do you want full access? Go Premium and unlock all 5 pages.
Access to all documents
Download any document
Ad free experience

Unformatted text preview:

ECON 2105 1nd Edition Lecture 8 Outline of Last Lecture I. Supply and Demand: Module 5, 6II. GDP: Module 10III. Module 11IV. Module 12Outline of Current Lecture I. Inflation Intro II. Real Variables III. Inflation CostsIV. Real Interest Rate V. PracticeCurrent Lecture Module 14 Inflation: An Overview I. Inflation Intro- If the US economy ends up with 10% inflation at the end of this year, how do you think your life will be affected from this high inflation? o Cost of living could go up (rent prices)o Goods and services could go up o Money saved- value could go down o Money owed- value could go down o Tuition rates- go upThese 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.- Inflation does NOT mean that all prices are rising (depends on what you buy whether there is inflation) o As of August 15, 2013 o Overall inflation 2% o Energy index inflation 4.7%o Natural gas 8.8%- Economy has inflation the power of your dollar is less. (because you have to pay more) o P= level of prices o If P goes up  inflation o Value of money= 1/P - How do we protect ourselves from inflation? o Landlord: rent prices – you would have to raise the price of rent accordingto inflation rate (adjust for inflation rate) o Lenders: interest rate- charge higher interest rate o Workers: wages- as boss to be paid more to adjust for cost of living o Tuition- according to college- they have to raise tuition rates because the cost of running the school has risen oII. Real Variables - 1$ in 1980s is not the same as 1$ in 2013 (because of inflation, cost of living has gone up)- Nominal wage- what you are being paid - Real Wage- the wage rate divided by the price level - Real Income- income divided by the price level- Real Interest Rate- nominal interest rate minus the rate of inflation - Price Level- hypothetical number to measure the overall prices over time and look at how it changes (not observable)- Price index- an approximation to the price level (observable) (unit-less) - A price index is a number that measures the average level of prices in a givenperiod relative to the average level of prices in some “base” period.- Nominal GDP/ Real GDP is a price index- Consumer Price Index (CPI)- Wholesale Price Index (WPI)- Producer Price Index (PPI)- Retail Price Index (RPI)5) House Price Index6) Services Producer Price IndexIII. Inflation Costs - Inflation rate= price index in year 2 – price index in year 1/price index in year 1 x 100- Ex> if the price index increases from 120 to 132 over a year what is the inflation rate?o Inflation rate: ((132-120)/120) X 100 = 10% - Shoe-leather cost: the increased cost of transactions cause by inflation o In Israel: inflation rate hit 500% in 1985, people spent a lot of time in line at banks. - Menu Cost: the real cost of changing a listed price - Unit- of-accounts cost: cost arising from the way inflation makes money a less reliable unit of measurement (calculations are hard when inflation is high) - Cost of unexpected inflation:Cost of Inflation Cost of Inflation If expectedIf expectedUnit-of-account costUnit-of-account costMenu CostMenu CostShoe-leather costShoe-leather costIf unexpectedIf unexpectedArbitrary redistribution of incomeArbitrary redistribution of incomeo As a borrower, we get money from lenders when there is not much inflation (so we can buy more) and we pay it back and if there is an increase in inflation, the money we pay can buy less in the future. o So, lenders charge an interest rate on their lending’s to protect themselves from inflation. o And, they do care more about the inflation-adjusted rate of return on lending’s. IV. Real Interest Rate - Nominal interest rate adjusted for inflation is called real interest rate. - Real interest rate= Nominal interest rate- inflation rate. - BUT, do we really know the inflation rate for the loan duration at the time of lending?- Say, you lend $1,000 to your friend to be paid in September 2014 and you charge him 10% interest. How much is the real interest rate? - Ex ante real interest rate: expected real interest rate (expected real return on lending) (expected real cost of borrowing) available at the beginning of contract o = nominal interest rate-expected inflation rate 10% - 2% = 8%- Ex post real interest rate: Actual or realized real interest rate (represents actual real return on lending) (actual real cost of borrowing) information available at theend of contract o = nominal interest rate- actual inflation rate-V. Practice - Assume that you borrowed $100,000 from a bank at 7% nominal interest rate to launch your business and at the time of the borrowing you were expecting 3% inflation for the duration of the loan. - But, you were mistaken in your inflation expectation. The actual inflation turns out to be 5%, not 3%. - Are you, as a borrower, better off or worse off with higher than expected inflation?o For a borrowers this is good, for a lender this is bad (they receive a less valuable amount of money o 7%-%5= 2%o 2% is the actual cost of borrowing o borrowers are better off with higher than expected inflation - Assume that you borrowed $100,000 from a bank at 7% nominal interest rate to launch your business and at the time of the borrowing you were expecting 3% inflation for the duration of the loan.- But, you were mistaken in your inflation expectation. The actual inflation turns out to be 1%, not 3%. - Are you, as a borrower, better off or worse off with lower than expected inflation?o For a borrower this is bad, for a lender this is good!o The money lenders they will get back is more valuableo 7%-1%=


View Full Document
Download Module 14
Our administrator received your request to download this document. We will send you the file to your email shortly.
Loading Unlocking...
Login

Join to view Module 14 and access 3M+ class-specific study document.

or
We will never post anything without your permission.
Don't have an account?
Sign Up

Join to view Module 14 2 2 and access 3M+ class-specific study document.

or

By creating an account you agree to our Privacy Policy and Terms Of Use

Already a member?