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Theme 2 > 2.1.2 Inflation > Flashcards

2.1.2 Inflation Flashcards

1
Q

Inflation

A

the rate at which the general level of prices in the economy rises - leads to a fall in purchasing power (money worth less/can buy less)

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2
Q

Who is inflation a problem for?

A

Inflation is not a problem for Purchasing Power Party if incomes are also rising but bad for people who have a fixed income (since income stays, but inflation rises)

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3
Q

Deflation

A

(opposite of inflation) when the average price level falls

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4
Q

Disinflation

A

a falling rate of inflation
- The average price level is still going up but slower than before, meaning g/s are relatively cheaper now than a year ago & the Purchasing Power of money has increased

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5
Q

Hyperinflation

A

the rate of inflation is high & volatile, to the extent that it’s out of control

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6
Q

Types of deflation

A

Benign vs Malevolent

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7
Q

How do we calculate the rate of inflation?

A

Using the Consumer Price Index

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8
Q

The Consumer Price Index

A

examines the weighted average prices of a basket of consumer g/s
- e.g transportation, food and medical care

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9
Q

How do we use the Consumer Price Index?

A
  • is calculated by taking price changes for each item in the predetermined basket of goods and averaging them
  • changes in the CPI are used to assess price changes associated with the cost of living
  • the CPI is an index number that shows the change compared to a base year/time period
  • this is then used to calculate inflation rate
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10
Q

What we need to know for the CPI (how to calculate it)?

A
  • need to know what people buy & how the prices of those things have changed
  • need an average/ typical basket of goods so that you know the significance of each of these goods/ services
  • then any price changes can be weighted to show significance
  • family expenditure survey helps identify the price & content of a typical basket of goods
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11
Q

Problems/ limitations with using CPI to measure inflation

A

It doesn’t include housing cost, no typical basket, regional differences (typical basket)

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12
Q

The Retail Prices index (RPI)

A

CPI plus housing costs (e.g accommodation costs & mortgage repayments)

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13
Q

Difference between CPI and RPI

A
  • CPI is lower than RPI
  • CPI used for international comparisons
  • CPI used for inflation target that the Bank of England’s Monetary Policy Committee is required to achieve
  • RPI is used to index various prices & incomes including tax allowances, state benefits, pensions
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14
Q

Causes of cost Push inflation

A
  • Tax (government policy)
  • Raw material (importing)
  • Labour
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15
Q

How does tax cause cost pull inflation?

A
  • if taxes rise = cost rise
  • shifts the AS curve inwards (raising prices)
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16
Q

How does raw material cause cost pull inflation?

A
  • importing raw materials = increased costs
  • shifts the AS curve inwards (raising prices)
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17
Q

How does labour cause cost pull inflation?

A
  • the wage-price spiral
  • when there’s inflation, firms need to increase wages, prices rise since pay rises, so wage increase (cycle)
  • also expectations (ppl expect a pay rise)
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18
Q

Causes of demand pull inflation

A
  • increase in AD = increased prices (when AD rises faster than economy’s productive capacity)
  • the closer you are to maximum capacity, the more demand for inflation
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19
Q

Why does increase in AD cause in demand pull inflation?

A
  • increase AD = increase prices in the short run
  • increase in AD may not increase prices if there is spare capacity in the economy
  • how much AD increase price level depends on where you are on the LRAS curve
  • if there is spare capacity then AD can increase without inflationary pressure
20
Q

Cost push inflation short run AS curve

A
21
Q

Cost push inflation long run AS curve

A
22
Q

Demand pull inflation short run AS curve

A
23
Q

Effects of inflation on consumers

A
  • inflation might reduce their purchases on certain things (especially elderly who are on fixed income)
  • Shoe leather costs
  • psychological costs
24
Q

Effects of inflation on consumers (shoe leather costs)

A
  • If prices are stable, consumer & firms will have some knowledge of which suppliers charge less but with inflation they don’t know
  • this leads to more shopping around
25
Q

Effects of inflation on consumers (psychological costs)

A
  • price increases are deeply unpopular, people feel that they are worse off
  • Consumer confidence can decrease
26
Q

Effects of inflation on firms:

A
  • reduced investments
  • hard to supply goods
  • menu costs
  • business confidence
27
Q

Effects of inflation on firms (investments)

A
  • firms may reduce their investments because they are less willing to take risks in an unstable macroeconomic climate
  • AD = decreased economic growth
28
Q

Effects of inflation on firms (supply goods)

A
  • if inflation reduce purchases on certain good
  • it makes it hard to supply goods since consumers might reduce their purchases
29
Q

Effects of inflation on firms (menu costs)

A
  • inflation means restaurants have to change menu prices/ calculate prices
30
Q

Effects of inflation on firms (business confidence)

A

If consumer confidence is low (due to consumers bing concerned about the future), business confidence is also low = lower investments

31
Q

Effects of inflation on workers

A
  • redistributional costs
  • inflation can redistribute income
  • Those with fixed income will suffer (e.g pensioners with fixed pensions which aren’t adjusted for inflation)
  • If prices double, real income will halve
  • if workers fail to negotiate pay increases in line with inflation, they will suffer falls in real income
32
Q

Effects of inflation on the government

A
  • international competitiveness
  • redistributional costs
33
Q

Effects of inflation on the government (international competitiveness)

A
  • Inflation means a balance of payment effect
  • If inflation rises faster in the UK than other countries & the value of the pound doesn’t change on foreign currency markets
  • exports are less competitive & imports are more competitive (=loss of jobs in the domestic economy & lower growth)
34
Q

Effects of inflation on the government (redistributional costs)

A
  • Taxes and govt may not change in line with inflation
  • (e.g if the Chancellor fails to increase personal income tax allowance ‘tax free’ in line with inflation, the burden of tax will increase, transferring resources from the taxpayer to the govt)
  • (or if they fill in increase excise duties on alcohol in line, real govt revenue will fall whilst drinkers will be better off , since incomes have risen with inflation)
35
Q

What causes increase inflationary pressures?

A
  • the growth of money supply
  • individuals and firm may spend their excess money on goods/services = increase AD
  • increase demand for labour = increase demand for goods = rise in wages = rise in costs of production
36
Q

How does hyperinflation occur?

A

Decreased tax revenue (due to war/change in commodity price/bad memory policies) = govt print money = increased money supply = increased inflation = periods of high inflation = decreased govt budget & confidence = more printing = increased inflation = currency collapses

37
Q

Evaluation of effects of inflation

A
  • effects of high inflation may depends on whether high inflation is temporary or persistent
  • depends on inflation relative to competitors (use numerical example)
  • whether nominal interest rates on savings & loans keep pace with inflation
38
Q

Why is inflation hard to forecast?

A
  • volatile global energy prices
  • govt indirect taxes can change
  • volatile food prices
  • uncertain growth of AD
  • changes in value of the currency
39
Q

Volatile energy prices example

A
40
Q

Causes of inflation

A
  1. Demand-pull inflation
  2. Cost-push inflation
  3. Devaluation
  4. Rising wages
  5. Expectations of inflation
41
Q

Causes of inflation (devaluation)

A

increasing cost of imported goods, and also the boost to domestic demand.

42
Q

Causes of inflation (rising wages)

A

higher wages increase firms costs and increase consumers’ disposable income to spend more

43
Q

Causes of inflation (expectations of inflation)

A

High inflation expectations causes workers to demand wage increases and firms to push up prices.

44
Q

Example of demand-pull inflation

A

In the 1980s, the UK experienced rapid economic growth
- the govt cut interest rates an tax
- house prices rose by up to 30%-causing a positive wealth effect and a rise in consumer confidence = higher spending, lower saving and increased borrowing

45
Q

Explain the role of the IMF in providing financial assistance to countries such a

A
46
Q

Why is controlling inflation important?

A

Low,stable inflation helps to promote macro stability – keeps domestic economy competitive and reduces business uncertainty

47
Q

Why might QE not work?

A

Consumer/business confidence

Theme 2 (19 decks)

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