2.1.2 inflation Flashcards
inflation (def.)
the sustained increase in the general price level of goods/services in an economy
what is the UK’s inflation target?
1-3% per year
deflation (def.)
a fall in the general price level of goods/services in an economy
when % change in prices is below 0%
disinflation (def.)
a reduction in the rate of inflation
general price level is still rising, but at a lower rate than before - Y1 = 5% but Y2 = 3%
how does the UK measure inflation?
consumer price index (CPI)
retail price index (RPI)
consumer price index (CPI) (def.)
a “household basket” of goods than an average family would purchase
the goods/services are weighted based on the proportion of household spending
consumer price index formula
CPI = (cost of basket in year X / cost of basket in base year) x 100
the % difference in CPI between the two years is the inflation rate for the period
dis. of using CPI to measure inflation
does not account for changes in quality of goods/services
only measures changes on an annual basis
prone to errors in data collection - small sample and not everyone has to fill out the survey nor truthfully/accurately
what are the different types of inflation?
demand pull inflation
cost push inflation
demand pull inflation (def.)
inflation caused by excess demand in the economy
what happens when AD shifts out?
if any component of AD increases, AD will shift to the right from AD1 to AD2
at P1, there is now excess demand (ceteris paribus)
as prices rise, there is a contraction of AD and an extension of SRAS
prices will have to increase to maintain equilibrium, from P1 to P2
cost push inflation (def.)
inflation caused by increases in the costs of production in an economy
what happens to SRAS if costs of production rise?
if costs of production rise, or there is a fall in productivity, SRAS will shift to the left from SRAS1 to SRAS2
at P1, there is excess demand (ceteris paribus)
as prices rise, there is a contraction of AD and an extension of SRAS
prices will have to increase to maintain equilibrium from P1 to P2
what effect does inflation have on firms?
creates uncertainty - may delay investment
what effect does inflation have on consumers?
decrease in purchasing power
decrease in the real value of savings - money will be worth less in real terms
fall in real income
