Examples of cost-push inflation in the following topics:
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- Inflation is a persistent increase in the general price level, and has three varieties: demand-pull, cost-push, and built-in.
- Cost-push inflation occurs when there is an increase in the costs of production.
- Unlike demand-pull inflation, cost-push inflation is not "too much money chasing too few goods," but rather, a decrease in the supply of goods, which raises prices .
- One major reason for cost-push inflation are supply shocks.
- Their employers then pass the higher labor costs on to customers through higher prices, which actually reflects inflation.
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- Aggregate supply shocks, such as increases in the costs of resources, can cause the Phillips curve to shift.
- The Phillips curve shows the relationship between inflation and unemployment.
- Stagflation is a combination of the words "stagnant" and "inflation," which are the characteristics of an economy experiencing stagflation: stagnating economic growth and high unemployment with simultaneously high inflation.
- As aggregate supply decreased, real GDP output decreased, which increased unemployment, and price level increased; in other words, the shift in aggregate supply created cost-push inflation.
- The resulting decrease in output and increase in inflation can cause the situation known as stagflation.
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- When inflation falls below this range, the Fed would lower interest rates and raising the money supply in order to push inflation up.
- Proponents of inflation targeting argue that a volatile inflation rate has negative effects for an economy.
- High levels of inflation eat away at savings, increase menu costs and shoe-leather costs, discourage lending, and may create an inflationary spiral that leads to hyperinflation.
- On the other hand, some argue that the costs of inflation targeting exceed the benefits.
- Argue that central banks should maintain inflation targets, Argue that central banks should not maintain inflation targets
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- This increased demand pushed up prices, leading to demands for higher wages, which pushed prices higher still in a continuing upward spiral.
- Labor contracts increasingly came to include automatic cost-of-living clauses, and the government began to peg some payments, such as those for Social Security, to the Consumer Price Index, the best-known gauge of inflation.
- While these practices helped workers and retirees cope with inflation, they perpetuated inflation.
- The government's ever-rising need for funds swelled the budget deficit and led to greater government borrowing, which in turn pushed up interest rates and increased costs for businesses and consumers even further.
- With energy costs and interest rates high, business investment languished and unemployment rose to uncomfortable levels.
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- When there is inflation, the value of the money borrowers pay back is less.
- When inflation is expected, it has few distribution effects between borrowers and lenders.
- This is because the inflation rate is built in to the nominal interest rate, which is the sum of the real interest rate and expected inflation.
- For example, if the real cost of borrowing money is 3% and inflation is expected to be 4%, the nominal interest rate on a loan would be 7%.
- Part of the reason that lenders charge interest is to recoup the cost of inflation over time.
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- The costs of inflation include menu costs, shoe leather costs, loss of purchasing power, and the redistribution of wealth.
- However, inflation does have some economic costs, especially when it is high or unexpected.
- Shoeleather cost refers to the cost of time and effort that people spend trying to counteract the effects of inflation, such as holding less cash, investing in different currencies with lower levels of inflation, and having to make additional trips to the bank.
- Other costs of high and/or unexpected inflation include the economic costs of hoarding and social unrest.
- The cost to a restaurant to change the prices on menus is incurred even with low and expected inflation.
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- Although the workers' real purchasing power declines, employers are now able to hire labor for a cheaper real cost.
- They demand a 4% increase in wages to increase their real purchasing power to previous levels, which raises labor costs for employers.
- As labor costs increase, profits decrease, and some workers are let go, increasing the unemployment rate.
- In the short run, it is possible to lower unemployment at the cost of higher inflation, but, eventually, worker expectations will catch up, and the economy will correct itself to the natural rate of unemployment with higher inflation.
- According to adaptive expectations theory, policies designed to lower unemployment will move the economy from point A through point B, a transition period when unemployment is temporarily lowered at the cost of higher inflation.
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- The index for another year (say, year 1) is calculated by $CPI_{year 1}=({Basket Cost}_{year 1}/{Basket Cost}_{base year}) * 100$
- The percent change in the CPI over time is the inflation rate.
- Now imagine that in the current period, bread still costs $4, jeans are $35, DVDs are $18, and gasoline is $4.
- Using the quantities from the base period, the total cost of the market basket in the current period is $212.
- When inflation is steady, incomes will generally compensate for the effects of inflation by rising or falling at approximately the same rate as the general price level.
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- The Phillips curve shows the inverse relationship between inflation and unemployment: as unemployment decreases, inflation increases.
- The Phillips curve relates the rate of inflation with the rate of unemployment.
- The Phillips curve argues that unemployment and inflation are inversely related: as levels of unemployment decrease, inflation increases.
- The Phillips curve offered potential economic policy outcomes: fiscal and monetary policy could be used to achieve full employment at the cost of higher price levels, or to lower inflation at the cost of lowered employment.
- In this image, an economy can either experience 3% unemployment at the cost of 6% of inflation, or increase unemployment to 5% to bring down the inflation levels to 2%.
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- In the long run, inflation and unemployment are unrelated.
- When unemployment is above the natural rate, inflation will decelerate.
- As nominal wages increase, production costs for the supplier increase, which diminishes profits.
- Consequently, an attempt to decrease unemployment at the cost of higher inflation in the short run led to higher inflation and no change in unemployment in the long run.
- According to the theory, the simultaneously high rates of unemployment and inflation could be explained because workers changed their inflation expectations, shifting the short-run Phillips curve, and increasing the prevailing rate of inflation in the economy.