Grade: 11 Lesson # 7
Who Benefits and Who does not Benefit from Unanticipated Inflation?
SS.912.FL.3.2Examine the ideas that inflation reduces the value of money, including savings, that the real interest rate expresses the rate of return on savings, taking into account the effect of inflation and that the real interest rate is calculated as the nominal interest rate minus the rate of inflation.
Correlated Literacy Standard:
LAFS.1112.RI.3.7 Integrate and evaluate multiple sources of information presented in different media or formats (e.g., visually, quantitatively) as well as in words in order to address a question or solve a problem.
SS.912.FL.3.2 Examine the ideas that inflation reduces the value of money, including savings, that the real interest rate expresses the rate of return on savings, taking into account the effect of inflation and that the real interest rate is calculated as the nominal interest rate minus the rate of inflation.
Who Benefits and Who does not Benefit from Unanticipated Inflation?
Lesson Number 7:
Correlated Florida Standards (See Full Text on Cover Page)
· LAFS.1112.RI.3.7
Essential Question
· Who benefits and who is hurt by unanticipated inflation?
Learning Goals/Objectives
· Define inflation, interest rates.
· Understand the difference between anticipated and unanticipated inflation.
· Explain the effects of inflation.
Overview
· Students will learn the fundamentals of inflation and how it is considered in current and future economic/financial decisions. Students will learn how certain people/institutions are affected by unanticipated inflation.
Materials
· CEE Advanced Placement Macroeconomics Activity 2-3 [included in lesson]
· CEE Advanced Placement Macroeconomics Activity 2-3 Answer Key [included in lesson]
· Note: both the above activity sheets taken from: Advanced Placement Economics Macroeconomics: Student Activities © National Council on Economic Education, New York, N.Y.
· “What is Inflation?” video from Investopedia.com http://www.investopedia.com/video/play/what-is-inflation/
· “Monetary Inflation” video from Investopedia.com http://www.investopedia.com/video/play/monetary-inflation/
· “Forces Behind Interest Rates” video from Investopedia.com http://www.investopedia.com/video/play/forces-behind-interest-rates/
Time
· One class period of 50 minutes.
Activity Sequence
INTRODUCTION/HOOK
· Show the “What is Inflation?,” “Monetary Inflation,” and “Forces Behind interest Rates” videos from Investopedia.com. [5 minutes]
ACTIVITY
1.Review the definition of inflation and interest rates. [5 minutes]
o Inflation is the rise in the overall price level; meaning the overall level of prices of all goods and services and that individual prices may increase or decrease during different periods of inflation.
o Interest rates are:
§ the cost of borrowing money by borrowers;
§ the charge for borrowing money by lenders, such as a bank;
§ investors may also earn interest by securing an interest-earning account such as a savings account or bond;
§ always listed as a percentage rate;
§ fixed interest rates are interest rates applied to a loan or interest-earning account that never change; and
§ Variable or adjustable interest rates are interest rates applied to a loan or interest-earning account that are changed given changes in inflation rates.
2. Discuss the difference between anticipated inflation and unanticipated inflation. [5 minutes]
o Anticipated inflation represents the level of inflation people expect to occur and have built into their economic decisions.
o Unanticipated inflation is the level of inflation that is not expected or unforeseen.
3. Explain how certain people benefit and lose with unanticipated inflation. [10 minutes]
o Who benefits:
§ Borrowers with loans (mortgages, auto loans) based on fixed interest rates?
§ Those who earn income with cost-of-living adjustments (COLAs)?
§ Those with fixed payments?
§ The federal government, as the largest borrower?
o Who loses:
§ Lenders (banks) of loans with fixed interest rates?
§ Those with savings accounts or other interest-earning accounts with fixed interest rates?
§ Those with fixed incomes?
4. Divide the class into groups of four or five and hand out Activity 2-3 to each group. [15 minutes]
o Students are instructed to collaborate on determining who gains, who is hurt, and uncertain on the various scenarios and offer explanations.
o Monitor progress and collaboration.
CLOSURE
· Review the answers to Activity 2-3 by asking each group a set of questions. Provide clarification if necessary. [10 minutes]
OPTIONAL EXTENSION SUGGESTION/HOME LEARNING
· Have students research the 1979 Energy Crisis with a focus on the gasoline prices and have them explain the affect of the inflation on the American economy and American consumer.
Sources/Bibliographic Information that contributed to this lesson:
Ray, Margaret. Advanced Placement Economics: Macroeconomics: Teacher Resource Manual, 4th Edition. National Council for Economic Education, 2012.
Who Is Hurt and Who Is Helped by Unanticipated Inflation?
In Questions 1 through 15 decide which people or groups are hurt by unanticipated inflation and which benefit from unanticipated inflation. Circle the correct response, and explain why you answered as you did.
H means the person or group is hurtby unanticipated inflation.
G means the person or group gains from unanticipated inflation.
U means it is uncertain if the person or group is affected by unanticipated inflation or if the
effects are unclear.
1 Banks extend many fixed-rate loans. H G U Explain:
2 A farmer buys machinery with a fixed-rate loan to be repaid over a 10-year period. H G U Explain:
3 Your family buys a new home with an adjustable-rate mortgage. H G U Explain:
4 Your savings from your summer job are in a savings account paying a fixed rate of interest. H G U Explain:
5 A widow lives entirely on income from fixed-rate corporate bonds. H G U Explain:
6. A retired couple lives entirely on income from a pension the woman receives from her former employer.
H G U Explain:
7. A retired man lives entirely on income from Social Security.
H G U Explain:
8. A retired bank official lives entirely on income from stock dividends.
H G U Explain:
9. The federal government has a $5,000,000,000 debt.
H G U Explain:
10. A firm signs a contract to provide maintenance services at a fixed rate for the next five years.
H G U Explain:
11. A state government receives revenue mainly from a progressive income tax.
H G U Explain:
12. A local government receives revenue mainly from fixed-rate license fees charged to businesses.
H G U Explain:
13. Your friend rents an apartment with a three-year lease.
H G U Explain:
14. A bank has loaned millions of dollars for home mortgages at a fixed rate of interest.
H G U Explain:
15. Parents are putting savings for their child’s college education in a bank savings account.
H G U Explain:
Advanced Placement Economics Macroeconomics: Student Activities © National Council on Economic Education, New York, N.Y.
Who Is Hurt and Who Is Helped by Unanticipated Inflation?
In Questions 1 through 15, decide which people or groups are hurt by unanticipated inflation and which benefit from unanticipated inflation. Circle the correct response, and explain why you answered as you did.
H means the person or group is hurt by unanticipated inflation.
G means the person or group gains from unanticipated inflation.
U means it is uncertain if the person or group is affected by unanticipated inflation or if the effects are unclear.
1. Banks extend many fixed-rate loans. H G U
Explain: The money the bank receives for the loan repayment will be less in real terms (purchasing power) than the loan amount.
2. A farmer buys machinery with a fixed-rate loan to be repaid over a 10-year period. H G U
Explain: Farmer makes payments that are less in real terms than the loan amount.
3. Your family buys a new home with an adjustable-rate mortgage. H G U
Explain: It depends on what happens to the future interest rate relative to the inflation rate. If the real interest rate rises, the family will be hurt.
4. Your savings from your summer job are in a savings account paying a fixed rate of interest. H G U
Explain: The return from savings will be worth less because of inflation and the fixed rate of return.
5. A widow lives entirely on income from fixed-rate corporate bonds. H G U
Explain: The purchasing power of the income will be less as inflation continues to deflate the value of the dollar.
6. A retired couple lives entirely on income from a pension the woman receives from her former employer.
H G U
Explain: It depends on whether the pension has a cost-of-living adjustment. If it does not, then the purchasing power of the pension payment will be less as inflation continues.
7. A retired man lives entirely on income from Social Security.
H G U
Explain: It depends on whether the Social Security payments are fully indexed for inflation. If Social Security payments do not increase at the same rate as inflation, then the retired man is hurt by inflation because he cannot puchase the same amount of goods and services.
8. A retired bank official lives entirely on income from stock dividends.
H G U
Explain: It depends on the growth in stock dividends relative to the inflation rate. In general, stock dividends increase with inflation while bond interest rates are fixed; however, the increase does not have to match the inflation rate.
9. The federal government has a $5,000,000,000 debt. H G U
Explain: The government will repay the debt with money that has less purchasing power.
10. A firm signs a contract to provide maintenance services at a fixed rate for the next five years.
H G U
Explain: Revenue from contract will be worth less.
11. A state government receives revenue mainly from a progressive income tax. H G U
Explain: It depends on how much tax revenue increases relative to inflation.
12. A local government receives revenue mainly from fixed-rate license fees it charges businesses.
H G U
Explain: Revenue will have a smaller purchasing power.
13. Your friend rents an apartment with a three-year lease.
H G U
Explain: Rent payments will be lower in real terms.
14. A bank has loaned millions of dollars for home mortgages at a fixed rate of interest.
H G U
Explain: Loan repayments will have less value or purchasing power.
15. Parents are putting savings for their child’s college education in a bank savings account.
H G U
Explain: It depends on the return on the savings relative to the inflation rate.
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