Inflation

Question 1

Define inflation

Answer 1

A general increase in the price level (normally measured as a % change over a time period)

Question 2

Which organisation measures inflation

Answer 2

The office for national statistics (ONS)

Question 3

How often does the ONS measure inflation?

Answer 3

Every month

Question 4

Describe how inflation is measured

Answer 4

The ONS purchase a basket of 700 goods. This basket is constantly updated to reflect current demand trends. Each item is weighted according to how significant a change in its price would be to households. The price of the basket is compared to the same month last year, and the percentage change is announced

Question 5

What are the two types of baskets?

Answer 5

• Retail price index (RPI)
• Consumer price index (CPI)

Question 6

What is the difference between the RPI and the CPI?

Answer 6

The RPI includes household expenses (like mortgages, rent and council tax), and these are not included in the CPI basket

Question 7

What is deflation?

Answer 7

When prices are generally falling

Question 8

Why is deflation bad?

Answer 8

People will delay spending as they wait for prices to continue falling. Businesses will then cut prices to try and increase demand. This can lead to a dangerous downward spiral

Question 9

What is disinflation?

Answer 9

This is where prices are still rising, but at a slower rate than they used to

Question 10

What are the two causes of inflation?

Answer 10

Cost push and demand pull

Question 11

Explain how a demand pull causes inflation

Answer 11

If aggregate demand increased but aggregate supply remained the same, prices would increase in order to reach a new equilibrium

Question 12

Give some examples of a coat of production

Answer 12

Raw materials and labour costs

Question 13

Explain how a coat push causes inflation

Answer 13

If the firm’s can’t afford to stay in the market or supply as much, aggregate supply will shift inwards. If aggregate demand remains constant, prices will have to rise for a new equilibrium to be reached

Question 14

Define nominal and real in terms of inflation

Answer 14

Nominal does not account for inflation, whereas real does

Question 15

What is a real interest rate?

Answer 15

An interest rate that takes inflation into account

Question 16

List the effects of inflation

Answer 16

• workers will seek a pay rise that is in line with inflation
• the government need to try and help people through the situation without making it worse
• the government are under pressure to increase benefits in line with inflation, which is extremely expensive
• inflation can be positive for government, because it erodes the value of debt
• inflation could cause higher interest rates for the government due to uncertainty, which could increase the value of debt
• could be good for savers as it leads to higher interest rates. However, the real interest rate is often negative, meaning this gets eroded
• poverty levels could increase if wages can’t keep up
• businesses will see their cost of production rise
• businesses will be less willing to invest because of the uncertainty

Question 17

How do the Bank of England’s inflation targets help control inflation?

Answer 17

They become self fulfilling because people act as if they are true, this is because the Bank of England is a legitimate, trusted body

Question 18

What is an index number?

Answer 18

Take data for a period of time for each year, the index gives the percentage change from the base number

Question 19

What are weights in terms of inflation?

Answer 19

Allow us to adjust raw data to account for the relative importance of items, such as those items bought frequently in the case of a price indexm

Question 20

Why does the CPI tend to give a lower rate than the RPI?

Answer 20

Because it excludes things like mortgage payments and tax changes

Question 21

A cost increase will do what to the aggregate supply curve?

Answer 21

Shift it upwards

Question 22

What are the three main causes of cost push inflation?

Answer 22

• an increase in the price of oil and other commodities
• wage increases
• a fall in the value of sterling, which makes imports more expensive

Question 23

What is the impact of inflation on firms?

Answer 23

• there is uncertainty about future costs, prices and revenue, and also about the availability of finance
• the damaged confidence leads to caution and an unwillingness to invest
• rising interests rates could disincentives borrowing
• demand will reduce if inflation decreases spending power
• workers may expect a pay rise,.which could lead to a wage price spiral
• imports become more expensive
• exporters will benefit, as their goods will seem cheaper on the international market

Question 24

What is the impact of inflation on individuals?

Answer 24

• those on fixed incomes will suffer
• those relying on the state pension may actually benefit from the triple lock. However, if the prices of what they buy rise faster than the basket of goods, they will still suffer
• anyone in debt will see the real value of their debt fall
• savers often experience a negative rate of interest in real terms, so the real value of their savings fall

Question 25

What is a the impact of inflation on government?

Answer 25

• inflation helps the government by reducing the real value of debt, but this could be offset by higher interest rates making debt more expensive
• they must walk the tight rope of helping people through the crisis while also working to tighten the monetary supply so as to not make the problem worse