Inflation

inflationdecade


Inflation
Inflation = Rate at which prices for goods and services rise.

Deflation = Rate at which prices for goods and services fall.

As you can see from the illustrations of inflation by decade above and inflation by year below, inflation is much more common than deflation.

inflationyear


Consumer Price Index
Consumer Price Index (CPI) = “Basket” of goods and services commonly used to measure inflation.

Components of the CPI include food, shelter, clothing, healthcare, transportation, education, recreation, and miscellaneous expenses.  These expenses are “weighted” to reflect their proportions in a typical household.

cpicomponents


Inflation and Interest Rates
In order to “fight” inflation, the Federal Reserve (Central Bank) of the United States raises interest rates.  Higher interest rates make it more difficult for households to borrow money to buy the goods and services comprising the CPI.  This reduced demand, in turn, forces the providers of these goods and services to lower their prices.  In this way, inflation is “tamed.”

inflationandinterestrates


Purchasing Power
Purchasing Power = Amount of goods and services that can be purchased with a given amount of money.

Over time, inflation eats away purchasing power.  For example, as per the line graph below, $100 in 1900 would have been able to purchase numerous cups of coffee.  Eroded by inflation, that $100 would now have a purchasing power of approximately $3.48, perhaps enough to purchase a single cup of coffee at a cafĂ©.

purchasingpower


Practice – Questions
The following histogram shows ranges of the inflation rate of the United States over several decades.inflationdecade
1.  Based on the histogram, in which decade was inflation at its highest?
A.  1920 – 1930
B.  1930 – 1940
C.  1980 – 1990
D.  1910 – 1920 

2.  Based on the histogram, in which decade was there some deflation?
A.  1910 – 1920
B.  1930 – 1940
C.  1980 – 1990
D.  1970 – 1980

The following line graph shows the inflation rate of the United States over several years.inflationyear
3.  Based on the line graph, in approximately which year did inflation spike?
A.  1910
B.  1992
C.  1960
D.  1980

4.  Based on the line graph, in approximately which year did deflation strike?
A.  1910
B.  1970
C.  1931
D.  1980

The following pie chart shows the components of the Consumer Price Index (CPI).cpicomponents
5.  Based on the pie chart, which component has the greatest weight in the CPI?
A.  Food & Beverages
B.  Apparel
C.  Medical Care
D.  Housing

6.  Based on the pie chart, which component has the least weight in the CPI?
A.  Food
B.  Apparel
C.  Other Goods & Services
D.  Housing

The following line graph shows the relationship between U.S. inflation and interest rates.inflationandinterestrates
7.  Based on the line graph, in approximately which year did the Federal Reserve feel compelled to raise interest rates to new heights to fight runaway inflation?
A.  2008
B.  2009
C.  1983
D.  1981

8.  Based on the line graph, in approximately which year did the Federal Reserve feel compelled to lower interest rates dramatically in the absence of runaway inflation?
A.  2008
B.  2009
C.  1983
D.  1981

The following line graph shows the decline in purchasing power of U.S currency over time.purchasingpower
9.  Based on the line graph, approximately how much would $100 earned in 1900 be worth in 1920?
A.  $100
B.  $80
C.  $60
D.  $40

10.  Based on the line graph, approximately how much would $100 earned in 1900 be worth in 2010?
A.  $100
B.  $3.48
C.  $40
D.  $80


Practice – Answers

1.  D.  1910 – 1920

2.  B.  1930 – 1940

3.  D.  1980

4.  C.  1931

5.  D.  Housing

6.  C.  Other Goods & Services

7.  D.  1981

8.  C.  1983

9.  D.  $40

10.  B.  $3.48

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