2.4 Inflation

Question 1

What is inflation

Answer 1

It is the sustained rise in the general price level over time

Question 2

What is deflation

Answer 2

It is where the average price level in the economy falls and there is a negative inflation rate

Question 3

What is disinflation

Answer 3

It is the falling rate of inflation. Where the average price level is still rising but to a slower extent

Question 4

What is hyperinflation

Answer 4

When the rate of inflation is high and accelerating to the extent that it is out of control

Question 5

What is the macroeconomic policy objective if low inflation

Answer 5

In the Uk, target inflation is 2%, measure with CPI. This aims to provide price stability for firms and consumers and helps make decisions in the long run

Question 6

What are real and nomial values

Answer 6

Real values have been adjusted for inflation

Nominal values have mot been adjusted for inflation

Question 7

How do you calculate the inflation rate in the Uk

Answer 7

This is done using the Consumer Price Index (CPI). It measures household purchasing power with the Family Expenditure Survey. This survey is used to create a basket of goods. The goods are weighted according to how much income is spent on each item

Question 8

What are the key points when answering an exam question on CPI

Answer 8

A survey is used

Weighted basket of goods

Measures average price changes of the goods

Updated anually

Question 9

What are the limitations of CPI when measuring inflation

Answer 9

The basket of goods is only representative of the average household

Different demographics have different spending patterns

CPI is slow to respond to new goods and services

Question 10

What is the retail price index (RPI)

Answer 10

It is an alternative measure of inflation. It also includes housing costs unlike CPI. It tends to have a higher value than CPI due to this inclusion. It has been used for longer than CPI so is better for comparison over time

Question 11

How are index numbers used to calculate the rate of inflation

Answer 11

Index numbers are used to make comparisons between years, and to measure the magnitude of change over time. A base year is used and is then compared to other years

Question 12

What are the three causes of inflation

Answer 12

Demand pull

Cost push

Growth of the money supply

Question 13

Why is demand pull a cause of inflation

Answer 13

This is from the demand side of the economy. When AD is growing unsustainably, there is pressure on resources. Producers increase prices to earn more profits

Question 14

What are the main triggers for demand pull inflation

Answer 14

A depreciation in the exchange rate

Lower taxes or more government spending

Lower interest rated

High growth in UK export markets

Question 15

Why is cost push a cause of inflation

Answer 15

This is from the supply side of the economy, and occurs when firms face rising costs

Question 16

When does cost push occur

Answer 16

Raw materials become more expensive

Labour becomes more expensive

Indirect taxes increase the cost of goods

Depreciation in the exchange rate

Question 17

Why is growth of the money supply a cause of inflation

Answer 17

Extreme increases in the money supply usually causes hyperinflation

Question 18

What are the consequences of inflation on consumers

Answer 18

Those on lower incomes are hit hardest because the cost of necessities become expensive

If consumers have loans the value of repayment will be lower because the amount owned doesn’t increase

Question 19

What are the consequences of inflation on firms

Answer 19

Low interest rates mean borrowing and investing is more attractive

Workers mught demand higher wages which can increases costs

Firms may be less globally competitive if inflation is high

Question 20

What are the consequences of inflation on the government

Answer 20

The government will have to increase the value of the state pension and welfare payments, because the cost of living is increasing

Question 21

What are the consequences of inflation on workers

Answer 21

Real incomes fall with inflation, so workers have less disposable income

If firms face higher costs there could be more redundancies when firms cut costs

Question 22

What are the two causes of deflation

Answer 22

A fall in aggregate demand

Increase in aggregate supply

Question 23

How does a fall in AD cause deflation

Answer 23

Deflation is usually caused in recessions when output and demand are decreasing.

Question 24

How does an increase in aggregate supply casue deflation

Answer 24

This lowers production costs for firms. Output increases at the same time, and this type of deflation is not normally considered as bad as if it caused by falling AD

Question 25

What are the consequences of deflation

Answer 25

The value of money increases

Sharp decline in consumer spending

The economy could crash and the unemployment rate might increase

Deflation causes the debt burden on consumers