34 Inflation

Question 1

Inflation

Answer 1

Increase in the average price level measured by a weighted basket of goods

Question 2

Deflation

Answer 2

Decreases in average price level measured by a weighted basket of goods

Question 3

Disinflation

Answer 3

A fall in the rate of inflation

Question 4

Hyperinflation

Answer 4

Excessively high rate of inflation

Question 5

Policy and objective of low and stable inflation

Answer 5

• provides price stability- Price level does not change or if change is very small it might not affect decisions significantly
• business and consumer confidence is promoted because they can factor their inflationary expectations nit their consumption and investment decisions - clearer expectation of the real value of money and return on investment
• high and volatile rates of inflation distorts price signals (which helps allocate scarce resources)- they also distort the price signalling function and also distort signals about purchasing power of their income and could lead to higher wage demands leading to cost-push inflation

Question 6

Causes of inflation

Answer 6

• demand-pull inflation - a result of a rise in aggregate demand in excess of aggregate supply , more significant when the economy experiences a rise in aggregate demand demand at a time of full employment
• cost-push inflation - a rise in the cost of production causes prices to rise on the supply side of the economy

Question 7

Cause of deflation

Answer 7

Lack of aggregate demand resulting in lower output and possibly deflationary spiral

Question 8

Consequences of deflation

Answer 8

• deflationary spiral - lower prices result in households and firms delay purchases in expectation prices will lower further therefore firm reduce output unemployment rises and then lower aggregate demand more downward pressure
• reduce confidence which reduces effectiveness of any government policy measures designing to increase activity
• bad deflation will change peoples expectation and behaviour - banks are likely to experience defaults on loans and worry about households ability to pay
• deflation van increase the burden debt on households, firms and governments. The amount that has to be repaid rises in real terms and this can further reduce C+I+G
• falling prices as a result of greater total factor productivity can increase the international competitiveness of a country export which improves the current account position on the balance of payments and increases the firms output and can help reduce unemployment as AD rises

Question 9

Consequences of inflation

Answer 9

• fall in value of money reduction in the real value of income and the purchasing power of income assuming incomes do not rise with the rate of inflation
• reduction in the real rate of interest and the return on savings and investments in the future
• uncertainty - about the costs of production and therefore unwilling to invest and consumers uncertain about value of income and could be confused whether to consumer or save
• loss of international competitiveness of exporting firms, inflation can erode the price competitiveness of exports and it also reduces the price competitiveness of domestically produced products compared to imports
• fiscal drag - people are dragged into higher tax brackets so pay higher proportion of income and fall of disposable income