GED Social Studies Practice Test: Business Cycles 2: Inflation, Deflation and Poverty

The Value of Money: Inflation and Deflation

You probably remember how much candy a dollar could buy when you were a kid. Today, that same dollar bill probably buys much less candy. When the value of money decreases, prices for goods and services goes up. It usually occurs when demand outstrips supply (and people are willing to pay more). Inflation decreases the purchasing power of consumers.

When prices decrease, and the amount of goods a dollar can buy increases, deflation occurs. This occurs when supply exceeds demand (for example, in the Great Depression). Deflation makes money more valuable.

There are two causes of inflation. Demand-pull inflation is the result of aggregate (total) demand increasing faster than an economy can produce goods and services. After World War II, for example, everyone wanted to buy a car (none had been made for 4 years). With 16 million people being mustered out of the armed services, there was a tremendous demand for cars, radios, apartments, and clothing. Demand was far higher than supply (the American economy was just beginning to convert from its wartime production back to civilian production). So, the prices of goods were pulled higher. If two people want the same apartment, the landlord can begin to ask for a higher price (and maybe even start a bidding war). When 50 women want the 30 dresses available, the price of each dress will rise.

The second cause is when the cost of producing a good or service must be raised (usually to cover the cost of increased natural resources). Here, producers must raise their prices in order to cover their costs and make a profit. Think of the oil companies after the oil shocks of the 1970s, when oil-producing nations began to decrease the shipments of petroleum to the U.S. The price of gasoline and heating oil soared. This is called cost-push inflation. If it costs me more to make or get something, I’m simply going to charge you more when you come around to buy it. In the chart below, you can see the deflation that occurred in the Great Depression, and the high inflation of the late 1970s and early 1980s.

Inflation usually hurts consumers. The amount of money they have will buy fewer goods. When there’s inflation, your money won’t go as far, and you may have to give up things: people spend money on necessary items like food and baby products, but non-essential purchases may dry up.

Inflation also hurts because you’re making the same salary, but costs of goods and services are going up. All of a sudden your salary, which once seemed adequate, isn’t covering rent, groceries, child care, and other things in your budget. Since you don’t “have as much money as you used to,” you’ll save and invest less.

Inflation is especially hard on those people who live on fixed incomes (such as people who receive disability payments or Social Security). In addition, when inflation is high, the interest rate on loans is higher, making it more difficult to borrow money.

Inflation does tend to make the value of assets such as real estate higher. If you sell your house in a period of high inflation (if you can), you may find you’ll walk away with more money.

Poverty in the United States

The United States is one of the richest nations in the world in terms of GDP, but that hardly means everyone is well-off, or even getting by. If a family of four in 2010 had an aggregate income of $26,675 or less, it was considered to be below the poverty threshold. In 2014, a single person making less than $11,670 would be below the poverty threshold; the 2014 threshold for a family of four is $23,850 (notice that it’s less than 2010 because the recovery from the Great Recession is a bit further along). According to the Bureau of the Census, 14.7 million people in the United States had a poverty level between 100% and 175% of the poverty level.

Certain areas of the U.S. have much more poverty than others. In regions where there tends to be a non-diversified economy (and overreliance on, for example, agriculture — especially in the South), there tends to be more poverty.

Today there is a growing income gap — you’ve probably heard of this referred to as “the one percent” (that is, the 1% of the American population with the greatest income). There’s no question that a small number of Americans control a proportion of the wealth far beyond their numbers would suggest. Finding sound data on this is hard, because many groups that compile figures have a political or ideological agenda

but, it’s generally agreed that the top 1% of population controls about a third of the total wealth in the U.S. The next quintile (20%) of the population controls about 48%, while the bottom 80% of the population controls only 19% of the wealth. In other words, the rich are getting richer, while the poor are getting poorer?

Is this good for democracy? Most would say not. Is it stoppable? Probably not, unless massive tax changes were to transfer much of the wealth. Raising the minimum wage, to lift more people out of poverty, might help, but it’s a very controversial idea (as you may already know from reading the newspapers and watching the news).


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