Inflation Case

Inflation & Unemployment;

The Twin Evils of Economics

Inflation is a general increase of price levels of goods and services in a country in the span of a certain period of time.

There are two main ways of measuring inflation:

1. Calculating the changes in the consumer price index. The consumer price index indicates the changes in prices of a certain fixed group of products and services of a certain typical customer, for example a housewife who regularly buys detergents and washing powder, which perhaps would exclude textbooks and spray-paint. The inflation rate would then be the percentage rate of change of a price index over time.

2. Calculating the GDP deflator. The GDP deflator is a more general measure, including all goods and services that are accounted for in the gross domestic product. The GDP deflator is calculated by taking the nominal GDP measure and dividing that by the real GDP measure, while taking account for a base year which will have the value of 100, as in the following formula:

GDP Deflator = (Nominal GDP / Real GDP) x 100

The consequences of high or unpredictable inflation rates are mostly harmful to the economy. Below are listed the main ways that high inflation rates can cause harm and inconveniences.

1. Financial wealth is eroded. Usually higher prices will automatically cause income to rise, since the increase of prices equals higher incomes for the firm owners, who again have the ability to increase the paycheck of their employees. The employees will then have more money to spend, which increases consumption, allowing for inflation to happen once more. This cycle just keeps on repeating over and over again.

2. Savings are discouraged, because the value of money will drop, basically leaving you with less than you had before. What is encouraged is wise investing in things that will not lose their value, such as gold. This way, you still have as much of a valuable possession as you did before, unlike the money that's value will surely decrease during times of inflation. Another method is changing the currency from the one with a rapidly decreasing value to a currency with a more stable one, and changing it back when the inflation slows down

3. Menu costs. Recourses are misallocated with the rising price. All menu cards, brochures and price tags must be reprinted, redistributed and replaced. This does not only require newly pressed items which use up paper, energy and capital to buy these new items, but also human recourses to distribute and replace the new menus and brochures. In conclusion a huge amount of time, money and other recourses are put into this process.

4. Inflation taxes. People who have lend out their money, will get repaid at a later date. When their money gets paid back, it will be the same amount but if will not obtain the same value as when the money was borrowed, thus allowing the lenders to end up with less than they initially had. In this situation, the borrower ends up with the last laugh, since the money they have to repay has less value than before, leaving themselves with a considerable profit.

What one might think is that banks might suffer greatly from inflation, since they are the considerably the biggest lenders. The reason they don't suffer as greatly is because they charge higher interest loans to keep them safe in times of high inflation. This method is called "Fisher's Hypothesis". It is measured by the following formula:

Nominal Interest Rate = Real Interest Rate + Expected Inflation

Unemployment consists of a group of people who are of normal working age (varies from country to country) that do not have a paid job, therefore do not have a salary and are actively looking for