who is hurt and who is helped by unanticipated inflation This is a topic that many people are looking for. savegooglewave.com is a channel providing useful information about learning, life, digital marketing and online courses …. it will help you have an overview and solid multi-faceted knowledge . Today, savegooglewave.com would like to introduce to you The Effect of Inflation and Unanticipated Inflation. Following along are instructions in the video below:
Okay so todays lesson is going to be on the impacts of inflation alright. Alright. So here we have three items.
An apple gasoline and diapers and were to imagine that were taking a trip to the local grocery store. And there are going to be prices that i expect on these items and then were gonna see how an impact of an unexpected price change will affect me okay so lets say that i go to the grocery store and i am expecting a pound of apples to cost a dollar per pound. However when i get to the grocery store apples have increased in price to 10 a pound clearly this would be a adverse situation for me as i want to purchase the apples.
But they have increased in price. Exponentially therefore this would hurt me or this inflation would hurt my ability to purchase the products that im used to purchasing now on the way home from the supermarket. I stopped to get some gasoline.
I am expecting gasoline to be about two dollars a gallon. However when i get to the gas station. I see that the gas prices have dropped to a dollar a gallon well this reduction in price is actually going to help me as i am able to now buy gas or free up some money to buy other things as a result of the decrease in price again on the way home.
I stopped to get some pampers diapers for my two year old and im expecting a box of diapers to be 26 dollars a box. And when i get there. Its a hundred and six dollars a box.
So this inflation would clearly hurt me as it would strip. My purchasing power of other items. Remember that inflation is a general increase in price level.
However prices can go up rapidly. They can hyper inflate but either way. If you are not expecting.
The inflation. And you have not properly prepared for the inflation. You can be hurt adversely by the inflation inflation does involve the general rise in prices.
But it is just as much about the purchasing power of the dollar. So when prices rise the value of the dollar decreases purchasing power is the amount of things that we can buy if the price of this bottle of water goes from 1 to 2. Now my dollar cannot buy as many water bottles.
Therefore i need more money to buy the same good that i purchased a day before with less money so purchasing power represents our ability to purchase goods and services based on the dollar and the value of that dollar during this lesson. Were going to look at people that are affected adversely by inflation one of those groups are people that live on a fixed income. Now theres lots of examples of people that live on a fixed income.
If your income is fixed that means that it does not increase when prices go up. Many different contracts are indexed to inflation. Where they receive a cost of living adjustment.
That is a cola so a cola is when your income will rise with inflation. And that is true in most cases for social security recipients or people that are on a retirement pension plan.
But some contracts just anticipate inflation and build in a cola to that contract now this is a graph representing social security cola and what you can see is that a social security recipients. Received for the most part increases throughout the mid 2000s to 2018. However in 2009 and 2010.
They did not receive any increase in their cost of living as well as 2015. So the reason they did not receive an increase in their cost of living or they received no cola was that inflation was very low in those preceding years. So in 2008 or 2009 of course.
We had the recession and in 2014 inflation was very low. But nonetheless social security payments are indexed to inflation. Now.
Lets look at how purchasing power can be impacted by inflation. Lets imagine that your employer says to you we are going to give you a 10 increase in pay from the previous year. And you think wow thats great thats amazing.
Id really appreciate that however when you turn on the news. You find out that the market basket of goods and services purchased by the average urban consumer has increased by 15 which means you are actually. 5.
Worse off than you were the previous year. So what that means is you received a nominal wage of 10 but in real terms you lost money in real terms. You received a decrease of 5 and the moral of the story here is that your salary must keep up with inflation or you are losing purchasing power.
Now inflation can either be anticipated or unanticipated anticipated inflation is expected inflation and of course. We expect about two to three percent every year. Its normal to have some inflation in fact it actually speaks to the health of an economy.
If we have some inflation particularly demand pull inflation that indicates that the economy is moving along as it should unanticipated inflation. However is when inflation becomes out of control or volatile or hard to predict. So unanticipated and inflation is inflation that is higher than we expected to determine the impact of inflation on interest rates.
We look at a formula. We can say that the real interest rate is equal to the nominal minus inflation or the nominal is equal to inflation plus. The real so here is a scenario.
Lets say you have a thousand dollars and you put it into a savings account youre gonna earn 3 simple interest or youll have 30 extra dollars at the end of the year. If inflation is 2. How much have you really gained well in real terms.
Youve gained one percent nominally you gain thirty dollars. But you really only gain ten. And that is because of the increase in price level again the moral of the story is your money must keep up with inflation or you are losing purchasing power in this case.
The 2 increase in price level. The market basket stripped the value of your earnings.
Okay. So lets talk about who is impacted by inflation first of all savers. We have a person that puts 100 into a fixed interest savings account.
If that person had that hundred dollars on them today. Then they could buy 100 worth of goods and services. Now lets fast forward a year.
Were expecting inflation to be three percent over the course of the year. If inflation is indeed three percent then they would need three percent more dollars to purchase the same amount of goods and services. They did the previous year therefore they would need one hundred and three dollars to buy that same amount of goods and services.
Now if they earn the three percent then its a no harm. No foul. They can buy the same amount of goods and services thus keeping up with inflation.
However. If prices unexpectedly rise to four percent and this individually has three percent more dollars than they have to take something out of their market basket. They have effectively lost a dollar.
So unexpected inflation can impact savers adversely. They would be hurt the next group of people that are affected by inflation are people that live on a fixed income. So i am a teacher and i receive a fixed income.
Which is based on a pre arranged contract which lasts at this point for two years at a time if we expect inflation to be three percent then every single year that i work i need three percent more money to compensate for the increase in the cost of living. If prices rise unexpectedly to six percent then i have automatically lost three percent of my earnings therefore. I would be hurt by unexpected inflation.
Now we talked before about social security recipients. How they do have a cola built into their contract. Which is pegged or indexed to inflation.
So. If inflation rises. They get a bump.
There are a lot of arguments that can be made that there are some weaknesses in this system such as that elderly people or social security recipients. Do not spend their money. The same way that the average urban consumer does they may spend more money on medical.
They spend less money on maybe clothing or something like that but nonetheless. They do have a cola built into their contract. So someone that is living on social security.
Which is pegged to inflation or indexed to inflation. What the very least be unaffected in a generalized way as i mentioned before sometimes people have this built into their contract for wages and as far as pensions go.
If you have a pension that is adjusted for inflation. You also would be unaffected by. Inflation now teachers in the state of.
Georgia receive a 15. Percent increase in pay in retirement every six months. If there is inflation now if inflation is low and they still receive that 15.
Percent or 3 percent annually. Then they are actually helped by inflation. Now heres an example of a young teacher.
Who becomes an old teacher lets say this young teacher is receiving wages of 3000. A month in 2016 when they first start their job they have a mortgage. Which cost them 1000.
Were going to say that their mortgage has a fixed interest rate. So that mortgage is not going to change. Lets just say in a general way over the course of 30 years.
However. What does change over the course of this 30 years is this teachers income as they receive cost of living adjustments. 30 year period is going to see them double their wages.
So their wages have doubled. Why have they doubled well they have a cola built into their contract that cola is adjusted for inflation. So their wages went up due to inflation.
Therefore. They can now pay this mortgage. Easier than they could when they first started as a teacher subsequently this teacher in some ways is helped by the inflation.
They borrowed money they locked in their interest rate. They hedge. It against inflation time passed they got paid more.
But they can pay their mortgage back much easier than they could prior to that point now heres another example. Lets say that this man here on the right wants to purchase a bottle of water. But doesnt have the money to do it so what do they do they go to the bank and they borrow the dollar.
So this guy borrows a dollar purchases. His bottled water and says look ill pay you back on tuesday. The bottle of water doubles in price.
Now he bought the bottle of water on monday. So hes good.
But now hes paying this banker back when he pays this banker back is he paying the banker back with dollars that are as valuable. No that dollar has less value as a result of the inflation. So that increase in the bottle of water to 2 stripped the value of that 1 bill that he was loaned and when he returns it to this banker that dollar will have less value in other words.
The banker is being paid back with less valuable dollars lenders are affected adversely by unexpected inflation. And the reason is theyre loaning money out expecting a certain rate. But if inflation is higher than theyre receiving lets say.
4 is what theyre receiving 6 inflation. Theyre actually being paid back with less valuable dollars ok. Another group of people that are affected adversely by inflation or low income.
If you think about it somebody thats working minimum wage at a grocery store is not guaranteed a raise when prices go up so if the price of goods and services are increasing exponentially and someones working a minimum wage chances are theyre probably not receiving a raise therefore low income or minimum wage workers are hurt by high prices or prices that go up beyond. What they are expecting now heres a picture of jeff bezos. Jeff bezos is a very wealthy man and quite frankly if we have 4 inflation or 5.
Inflation. That probably doesnt mean a lot to jeff bezos. This is not going to have an impact on him so it is commonly said that the wealthy who have a lot of their money invested their money is exceeding inflation.
So they dont really have to worry about the inflation. As much as they have more money available to them at the very least. Jeff bezos would probably be unaffected by marginal increases in inflation now he might care about hyperinflation.
But if its above normal inflation. Its probably not gonna affect him as much as it would someone thats a low income worker. Okay lets take the last group lets say that you and i agree to a three year contract for babysitting services youre gonna babysit my children and were gonna lock this in for three years we settle on 15 an hour in other words im gonna pay you 15 an hour to take care of my kids now lets imagine that prices rise exponentially.
However your pay is locked in for three years. Well. Heres the deal while your wages stay the same everything else is going up in price.
And again this can hurt you because you have locked in your contract for multiple years as a result. The inflation is stripping the value of the money you are earning. And you are hurt by this inflationary condition.
Who has helped is the firm. The firm is now paying back the worker or in this case. I am paying you less money to take care of my children.
So heres a little table where we can break all this down hurt. Helped unaffected again who is hurt by inflation our low income or fixed. Income workers.
People that are savers that have relatively low interest rates in their savings account or lenders who are paid back with less valuable dollars on loans that they made so low income savers lenders and people on a fixed income who is unaffected are people that have a cola that is indexed to inflation borrowers. That are paying back at fixed interest rates with less valuable dollars and firms like the babysitting example that have made pre arranged fixed income contracts where the wages are not going to change okay so this is an introduction to inflation and the impact of inflation on these various groups hope you enjoyed the video and thank you for watching. .
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