Inflation Flashcards
What is inflation?
Inflation is the sustained rise in general price levels overtime
When does demand pull inflation occur and why does it occur?
This occurs when AD shifts to the right.
As AD shifts to the right, theres greater pressure on existing fop to produce more output. As a result, firms increase price.
When does cost push inflation occur and why does it occur?
This occurs when SRAS shifts to the left
When firms experience higher costs of production, they may pass this onto consumers through higher prices.
What can cause the AD shift to the right?
1) decreasing interest rates. it will be cheaper for consumers to borrow and spend. it will be cheaper to invest.
2) decreasing income or corporation taxes. this increases disposable income. lower costs for businesses aswell.
3) Higher consumer or business confidence. Increases consumption and investment.
4) Higher government spending.
5) Weaker exchange rate. Demand for domestic products increases.
What can cause SRAS to shift to the left?
1) Increased raw material prices. More expensive to produce.
2) Increased wages. Costs for businesses.
3) Increased business taxes. EG: VAT
4) Price of imported materials rising due to weaker exchange rate.
What are some costs to high inflation?
1) Loss of purchasing power
2) Erosion of savings since interest rates may not follow inflation rates.
3) Lower export competition. If inflation is high in one country relative to others, then that country is less export competitive.
4) Wages Spirals. High prices means workers will bargain for higher wages. If given this will increase costs for firms more leading to prices increasing again. Workers will then ask for more again.
5) Consumer Spirals. If consumers anticipate increase in prices, they will rush to consume. If everyone does this, prices will sky rocket.
6) Fiscal Drag. If incomes rise in line with inflation, its pointless. But this may lead them to higher tax brackets making them worse off. This decreases living standards.
What are some benefits of low and stable inflation?
1) Workers can bargain for higher wages. Its nice to see higher incomes.
2) Consumption is more natural since there is no anticipation.
3) Firms encouraged to increase output as they know they can increase prices slightly and earn more.
4) It can keep unemployment low in a recession, firms naturally sack workers but they dont want to get rid of workers since they are experienced and skilled. If theres some inflation, they may raise prices in line with inflation. This extra revenue enables them to increase wages slightly keeping workers.
5) Improvement of gov finances. Theres a fiscal windfall where higher prices will mean more tax revenue. EG: VAT
6) Reduces real value of debt. This is because workers can bargain for higher wages and firms can earn more.
Evaluation for cost and benefits of inflation
1) Rate. If inflation is low and stable, theres more benefits than costs.
2) Type of inflation. Cost push tends to be worse. Demand pull increases growth and employment at the same time. Cost push theres decreased growth and employment. Cost push is also harder to solve.
3) Duration. Long term high inflation means more anticipation. This can lead to more price spirals.
4) Stability. If inflation is more volatile, it is more costly.
