05 Inflation, Unemployment, Growth and Balance of Payments

Question 1

Define inflation

Answer 1

The rise in the average price level and fall in the purchasing power of money.

Question 2

Define deflation

Answer 2

The fall in the average price level and rise in the purchasing power of money.

Question 3

Define disinflation

Answer 3

Disinflation is a fall in the rate of inflation but not sufficient to bring about price deflation. During a period of disinflation, consumer prices are still rising but at a slower rate.

Question 4

What is the UK government’s inflation target?

Answer 4

2% CPI (+ or - 1%)

Question 5

Who is in charge of achieving the target rate of inflation and what is their main tool to do so?

Answer 5

The Bank of England - governor Andrew Bailey - use monetary policy such as setting interest rates.

Question 6

How is inflation measures?

Answer 6

Consumer Price Index (CPI)
Retail Price Index (RPI) - contains housing costs such as:
- Council tax
- Mortgage
- House depreciation
- Building insurance

Question 7

What is the relationship between CPI and RPI over time?

Answer 7

CPI and RPI are positively correlated with RPI being more volatile, as it includes housing costs.

Question 8

Why does the government target 2% inflation specifically?

Answer 8

To keep inflation low and stable. Deflation could be harmful.

Question 9

How will the Bank of England reducing interest rates impact the macroeconomic objectives?

Answer 9

C - rise
I - rise
X - rise
M - fall

Question 10

What is a wage price spiral?

Answer 10

• Most likely to occur when the economy is nearing its productive capacity
• If they are, they will seek to attract resources to expand - labour being part of these
• Any skilled labour is likely to be employed and so firms have to offer more attractive packages to persuade people to move from one job to another thus increasing their expectations
• Employees will want to compensated for the higher prices - don’t want a full in purchasing power
• Push for higher wages - higher wages push up costs - firms put up prices again - if prices rise again, people will push for even higher wages
• Can be difficult to get rid of - people built the increased inflation level into their costs

Question 11

Define demand pull inflation

Answer 11

A period of inflation which arises from rapid growth in aggregate demand.

Question 12

Define cost push inflation.

Answer 12

Occurs when prices rise due to higher costs of production and higher costs of raw material.

Question 13

What type of inflation will a rise in the NMW cause?

Answer 13

Cost push inflation.

Question 14

What type of inflation will a fall in interest rates cause?

Answer 14

Demand pull inflation.

Question 15

What type of inflation will a reduction in labour productivity cause?

Answer 15

Cost push inflation.

Question 16

What are the problems with deflation?

Answer 16

• Debts increase - more difficult to pay off
• Holding back on spending
• Real wage unemployment
• Increased interest rates
• Lower profit margins - due to lower prices
• Confidence and saving - consumers may postpone C if they expect prices to fall in future

Question 17

Why may demand-pull inflation be more beneficial for the macroeconomy?

Answer 17

• Creates growth

- Decreases unemployment

Question 18

What are the consequences of inflation?

Answer 18

• Business uncertainty
• Inequality
• Falling real incomes - if wage prices lag behind price
• Negative real interest rates
• Cost of borrowing
• Risk of wage inflation
• Business competitiveness can reduce

Question 19

Why does inflation have a large redistribution effect?

Answer 19

• Leading to changes in income/wealth for households, firms and the state
• It also erodes the value of money overtime affecting people on fixed incomes

Question 20

Who benefits from inflation, and who suffers?

Answer 20

Benefits:
- Borrowers will see the value of their debt shrink in real terms
Suffers:
- Savers will be made worse off as a result, as the real value of their savings will go down
- Those on fixed incomes (pensions) will see their real incomes fall

Question 21

How will inflation impact investment and growth?

Answer 21

Low and stable inflation creates a stable environment for invest, benefitting the economic growth of an economy - higher, volatile inflation may discourage investment
- Any boost to investment will increase AD and AS, therefore increasing UK economic growth

Question 22

What will the effect of inflation be on competitiveness?

Answer 22

• Other factors being equal, a higher price level in the economy will make UK exports less competitive and imports more competitive
• Will have an adverse affect on the balance of paymenths
• But this assumes the exchange rate does not change and does not take into account the quality of exports and imports

Question 23

Define unemployement.

Answer 23

Everyone who is willing, able and available to work, but can’t find work.

Question 24

What does the claimant count measure?

Answer 24

The number of people claiming JSA.

Question 25

What does the Labour Force Survey measure?

Answer 25

The number of people who have looked for a job in the last 4 weeks and can start work in the next 2 weeks.

Question 26

What are the main causes of unemployment?

Answer 26

• Rise in costs of production for firms - i.e., NMW/NLW
• Automation and technology - labour being replaced
• Closure of large industries
• Geographical immobility
• Time of year

Question 27

Define frictional unemployment.

Answer 27

When people move between jobs e.g.., new entrants to the labour market.

Question 28

Define structural unemployement.

Answer 28

When there is a mismatch between workers skills and the requirements of the new job opportunities

Question 29

Define cyclical unemployment.

Answer 29

When there is a lack of demand for goods and services (e.g., during a recession)
- Where many businesses close down or ‘down-size’ to maintain profits

Question 30

Define seasonal unemployement.

Answer 30

Due to the season of the year.

Question 31

Define voluntary unemployment.

Answer 31

Economically inactive.