2.1.2

Question 1

what is inflation

Answer 1

an increase in the general level of prices - the average price of all goods and services increases. implies that the value of money falls. more money is now required to buy the same set of goods and services

Question 2

what is disinflation

Answer 2

when the rate of inflation falls but does not become negative. prices are still rising but at a slower rate. value of money is still falling
eg the inflation falls from 4% to 2%

Question 3

what is deflation

Answer 3

when the rate of inflation becomes negative. in this case the average price level falls. Value of money increases. less money is now required to buy the same set of goods and services

Question 4

what is accelerating inflation

Answer 4

where the rate of inflation increases

Question 5

what is hyper-inflation

Answer 5

where the rate of inflation becomes so high that it leads to the break-down of the currency - germany 1923

Question 6

how can inflation be measured

Answer 6

• the consumer price index (CPI)
• retail prices index (RPI)

Question 7

what is the consumer price index (CPI)

Answer 7

measure of inflation that is targeted by the BofE and is generally considered to be the better measure. it is also used as the benchmark by which any index-linked payments are increased such as state pensions. it doesn’t include housing cost

Question 8

what is the retail price index (RPI)

Answer 8

measure of inflation that does include housing costs, council tax, mortgage interest payments, house depreciation, and other house purchasing cost such as estate agent fees

Question 9

what does index-linked mean

Answer 9

based on inflation

Question 10

where are all the government statistics from

Answer 10

the office for national statistics (ONS)

Question 11

what does the living cost and food survey measure

Answer 11

what people buy and % of income they devote to each good and service (weight) each month

Question 12

how does the ONS use the living cost and food survey to calculate inflation

Answer 12

finds the price change as a % of all goods and services identified in the survey

Question 13

how does the ONS use the inflation rate to calculate the weight index

Answer 13

inflation rate of each goods and services is multiplied by its weight expressed as a decimal

Question 14

what are the limitations of the CPI

Answer 14

• inflation varies between individuals and regions and the CPI just finds the average
• doesn’t capture the quality of the product and this changes over time
• time lag as it measures changes in consumption on an annual basis
• prone to errors in data collection as its taken through a survey
• small sample leading to sample bias
• one of several methods used by countries in determining inflation (another is RPI) - making comparisons between countries less meaningful

Question 15

how does cost-push factors effect inflation

Answer 15

• caused by the rising cost of inputs of production
• forces producers to pass on higher costs to consumers in the form of higher prices
• causes aggregate supply to shift left

Question 16

how does a rise in wages cause inflation (cost-push inflation)

Answer 16

increased wage when wages make up a significant proportion of the firms cost of production then it would lead to a significant price increase

Question 17

how does a rise in cost imported of raw materials cause inflation (cost-push inflation)

Answer 17

• producers pay higher costs and set higher prices/ increase in world commodity prices
• currency depreciation (WIPIDEC) leads to an increase price for the same imports

Question 18

how does a rise in indirect tax cause inflation (cost-push inflation)

Answer 18

• increase in cost due to added tax leads to higher prices
• the more inelastic the PED, the most of the cost of the tax will be passed on to the consumer

Question 19

types of policies to address cost-push inflation

Answer 19

• restriction in wage increase, primarily in the public sector -> could lead to inflexible labour market and large subsequent gains
• reduction in corporation tax -> reduce cost to businesses, could also increase investment
• subsidies -> to reduce costs, but could lead to inefficiencies
• supply side policies

Question 20

how has cost-push inflation been caused by recent real life events

Answer 20

• rising energy prices due to ukraine war
• rising shipping costs due to congestion at ports and lockdowns in china
• rising commodity prices
• bottlenecks in global supply chains due to unexpected demand following end of covid lockdown
• tightening labour market and some normal wage inflation

Question 21

how does demand-pull factors effect inflation

Answer 21

• caused by excessive growth in aggregate demand compare with supply
• causes aggregate demand curve to shift to the right
• allows sellers to raise prices

Question 22

how does high consumer spending or high demand for exports cause inflation (demand-pull inflation)

Answer 22

domestic demand - caused by confidence, low interest rates

foreign demand - high economic growth overseas, low exchange rate

Question 23

how does the money supply growing faster than output cause inflation (demand-pull inflation)

Answer 23

“too much money chasing too few goods”
could be caused by very low interest rates, leading to high borrowing (creating greater money supply)

Question 24

how does bottleneck shortages cause inflation (demand-pull inflation)

Answer 24

the factors of production are being fully used when there is a significant increase in aggregate demand
leading to shortages and therefore higher prices

Question 25

fiscal policies to address demand-pull inflation

Answer 25

- controlling aggregate demand is important if inflation is to be controlled -> government 'tightening fiscal policies - reducing its own spending on public and merit goods or welfare payments - raise direct taxes, leading to a reduction in real disposable income - demand and output are lower which has negative effect on jobs and real economic growth in the short-tern

Question 26

how can inflation be reduced

Answer 26

reduced by policies that slow down the growth of AD and/or boost the rate of growth of aggregate demand

Question 27

monetary policies to address demand-pull inflation

Answer 27

- 'tightening of monetary policy' involves the central bank introducing a period of higher interest rates -> reduce consumer and investment spending - higher interest rates -> causes exchange rate to appreciate in value -> causing fall in the cost of imported goods (lower cost push inflation) and services and also a fall in demand for exports (X)

Question 28

supply side polices to address demand-pull inflation

Answer 28

- increase productivity, competition and innovation to maintain a lower price overcome bottleneck and output problems: - reduction in company taxes to encourage greater investment - reduction in taxes which increase risk-taking and incentives to work -> a cut in income taxes can be considered both a fiscal and supply side policy - policies to open a market to more competition to increase supply and lower prices

Question 29

direct controls to address demand-pull inflation

Answer 29

- a government might choose to introduce direct controls on some prices and wages - freeze or tightly control public sector pay awards meaning a real wage decrease - regulatory controls on some utility

Question 30

what is the most appropriate way for the government and central bank to control inflation

Answer 30

keep the control of aggregate demand to a level consistent with the productive capacity

Question 31

how should the government control ad

Answer 31

through monetary policies rather than an over reliance on on fiscal policies

Question 32

why does controlling demand be inefficective in the short run

Answer 32

the main causes could be due to cost push inflation or external shocks have cause the high prices

Question 33

how in the long run does the government control inflation

Answer 33

the growth of a countries supply-side productive potential capacity that makes the economy grow

Question 34

how are consumers negatively affected by inflation

Answer 34

- decreasing purchasing power that leads to a reduction in living standards that effects people on fixed incomes/ pensions/ low income employment - decrease in real value of savings - 'shoe leather cost' which is the costs of extra time and effort taken by consumers to search for up to date price information

Question 35

how are firms negatively effected by inflation

Answer 35

- uncertainty due to rapid price changes that results in delayed investment - 'menu' change cost that forces firms to change their prices which takes time and is expensive

Question 36

how are government negatively affected by inflation

Answer 36

- inflation erodes international competitiveness of export industries - trade-offs involved in tackling inflation such as reducing inflation may increase unemployment and/or reduce economic growth

Question 37

how are workers negatively affected by inflation

Answer 37

- demand higher wages to compensate for reduced purchasing power which leads to a wage-price inflation spiral - if wage increase is less than inflation then motivation and productivity may fall - fiscal drag which is when their income is dragged up to a higher tax rate as their income increases and so does the the tax bracket

Question 38

what are the positive effect of inflation on consumers

Answer 38

- increase in the real value of borrowing (as money to be paid back will be worth more in real terms) but makes it more attractive to borrow, leading to prices to rise further

Question 39

what are the positive effects of inflation on firms

Answer 39

- increase in output in lead with increased levels of demand (demand-pull inflation)

Question 40

what are the positive effects of inflation on the government

Answer 40

- can keep unemployment low in recession, with higher levels of ad - can improve government finances via fiscal drag

Question 41

what are the positive effects of inflation on workers

Answer 41

in receipt of higher wages, if can negotiate pay rises

Question 42

what are the evaluative considerations of the effects of inflation

Answer 42

- rate of inflation - causes of inflation - duration - anticipation vs unanticipated - rate of change/ stability of prices

Question 43

what does demand side deflation (bad/malignant) cause

Answer 43

- comes with lower levels of economic growth and tend to be more long term - happens in a recession that is anticipated - modled on a keynsian diagram

Question 44

what does a supply side deflation (good/benign) cause

Answer 44

- comes with higher levels of economic growth and tends to be short term - decrease in cost of production due to decrease tax or price of raw materials due to price fluctation or SPICED

Question 45

what are the negative effects of deflation on the consumer

Answer 45

they hold back spending - causing consumption to fall further - reduction in ad - fall in price level/ demand side deflation - further delaying spending - creating a deflationary spiral increase in real debts - reducing consumer confidence - consumers defaulting on loans increase in the real cost of borrowing - the real increase rate will rise if the nominal/ money/ actual rate of interest does not fall in line with prices - discuraging borrowing and spending - leading to lower consumption and investment - reducing ad further - causing a deflationary spiral confidence and savings - falling asset prices leading to a negative wealth effect - fall in consumption - reducing ad further - causing a deflationary spiral

Question 46

how does deflation negatively effect firms

Answer 46

lower profit margins - lower prices means reduced revenues and profits for businesses -higher unemployment as firms look to cut costs increase in real debt - reduces business confidence - businesses defaulting on loans

Question 47

how does deflation negatively effect the government