2.4 inflation

Question 1

define inflation

Answer 1

a sustained increase in the average price level. the rate of change of the average pice level - the % annual rate of change of the consumer price index

Question 2

define disinflation

Answer 2

a fall in the inflation rate. it means that the general price level is increasing at a slower rate

Question 3

define deflation

Answer 3

when there is actually a fall in the average PL (negative inflation)

Question 4

define hyperinflation

Answer 4

a rapis and unchecked increase in the PL. typically it involves inflation rates of greater than 50% or even greater than 1000%

Question 5

explain the policy objective of low/stable inflation

Answer 5

attempts to create stability in the overall equilibrium PL. gov’s target is 2% (CPI)

Question 6

why is the target of low and stable inflation important

Answer 6

high/volatile inflation may deter firms from investing and therefore hinder EG. firms base investment decisions on future expectations. inflation makes it hard to form reliable expectations for the future. a stable macro environment is crucial for EG to happen

Question 7

define nominal values in the context of inflation

Answer 7

the unadjusted rate or current price, without taking inflation into account

Question 8

define real values in the context of inflation

Answer 8

adjustments are made for general PL changes (inflation) over time

Question 9

how to calculate index numbers

Answer 9

current value of index = (current value/base value) x 100 –> to compare 2 years not including the base year calculate % change

Question 10

how do we measure inflation

Answer 10

consumer prices index (CPI) and the retail prices index (RPI) - two baskets comprising different goods and services. both weighted price indexes based on how often goods are bought - changes in weight reflect shifts in spending patterns as measured by the family expenditure survey

Question 11

difference between cpi and rpi

Answer 11

rpi includes housing costs like mortgage interest payments and council tax but cpi doesn’t

Question 12

detail about the cpi

Answer 12

inflation rate is calculated each month by looking at changes in prices for over 700 goods and services in 150 different areas in the UK. known as the basket of goods and is regularly updated to reflect changes

Question 13

how to calculate a weighted price index for this year

Answer 13

the sum of (price x weight)/ sum of the weights

Question 14

how to calculate rate of inflation

Answer 14

the % change in price index from one year to another

Question 15

advantages of using cpi and rpi to measure inflation

Answer 15

large categories make cpi a legit indicator, measurable (quantifiable)

Question 16

disadvantages of using cpi and rpi to measure inflation

Answer 16

few households are exactly average, not fully representative of all households, different people have different spending patterns, new products may not be accounted for as the cpi is slow to respond to new products or services

Question 17

name the causes/types of inflation

Answer 17

demand pull, cost push

Question 18

explain demand pull inflation

Answer 18

higher aggregate demand pulls prices up. ad shifts to the right

Question 19

explain cost push inflation

Answer 19

supply decreases because costs of production have increased. can be caused by higher wages, higher raw material prices, higher business taxes, higher cost of imports due to a weaker exchange rate. sras shifts to the left, increasing the PL

Question 20

why should there be a persistent price increase over time

Answer 20

a moderate rate of inflation is consistent with a steady rate of EG

Question 21

name consequences of inflation

Answer 21

1. fall in the value of money - falling real incomes
2. menu costs
3. shoe leather costs
4. inflationary noise/impact on resource allocation
5. impact on inequality
6. fiscal drag
7. uncertainty and investment
8. loss of international competitiveness

Question 22

explain 1. fall in the value of money - falling real incomes

Answer 22

money can now buy less than it could the year before because of inflation as it’s worth less. consumers can buy less

Question 23

explain 2. menu costs

Answer 23

restaurants constantly having to reprint menus due to changes in prices

Question 24

explain 3. shoe leather costs

Answer 24

the cost of having to move money between different financial institutions to try and minimise the impacts of inflation (i.e having to carry your money and ‘walk’ to a different financial institution thus wearing out the leather of your shoes)

Question 25

explain 4. impact on resource allocation

Answer 25

price usually acts as a way to decide where resources are allocated. inflation may mean it can't reliably do this so resources are misallocated and business opportunities may be lost

Question 26

explain 5. impact on inequality

Answer 26

some groups in society will be less able to protect themselves against rising prices so this increases inequality. eg pensioners and those on fixed incomes now have less buying power because their incomes/savings are diluted by rising prices and so they are some of the most disadvantaged

Question 27

explain 6. fiscal drag

Answer 27

inflation means higher wages means people are in a higher tax bracket meaning they may be worse off as are losing more money to taxation

Question 28

explain 7. uncertainty and investment

Answer 28

if firms can't confidently say what the rate of inflation will be in the future this increases their uncertainty. more uncertainty can make them reluctant to undertake investments to increase their productive potential as they don't know if demand will be high enough in the future to justify this

Question 29

explain 8. loss of international competitiveness

Answer 29

higher inflation in a country may make other countries less inclined to buy goods from them as they're more expensive so they buy goods from other countries instead

Question 30

the benefits of inflation

Answer 30

low and stable demand pull inflation may encourage firms to increase their output, workers may feel more appreciated if their wages increase even if real pay doesn't, allows firms to cut real wages - improving labour markets

Question 31

evaluate the significance of inflation

Answer 31

the impact of it depends on the rate, the cause, the fluctuations, and the comparison with other economies. low stable rate is generally okay. cost push is more harmful as it usually leads to a fall in real gdp

Question 32

why might deflation be economically damaging

Answer 32

1. holding back on spending if consumers think it will be cheaper in future 2. debts increase 3. the real cost of borrowing increases 4. lower profit margins

Question 33

causes of deflation

Answer 33

falling ad, lower production costs