Inflation

Question 1

definition

inflation

Answer 1

A sustained rise in the general price level

Question 2

common measures of inflation

CPI or RPI

Consumer price indext or retail price index

Answer 2

meaures the changes in prices of a weighted basket of goods bought by consumers over a given period of time

Question 3

common measures of inflation

PPI

producer price index

Answer 3

a weighted basket of final goods & services and intermediate goods in the production process. e.g. raw materials

Leading indicator for changes in CPI *if producer prices increase is likely to be pased down to consumers

Question 4

common measures of inflation

GDP deflator

Answer 4

used to convert GDP nominal figures to real figures.

Also includes goods and services produced by governments.

CALCULATION
(Nominal GDP/Real GDP) X 100

Question 5

terminology

inflation rate

Answer 5

the percentage change in prices from one period to another

Question 6

terminology

defelation

Answer 6

a persistent fall in the general price level

Question 7

terminology

Disinflation

Answer 7

a general rise in price levels BUT at a lower rate of inflation

Question 8

terminology

core or underlying inflation

Answer 8

a measure of inflation excludes volatile prices in the basket e.g excludes prices of oil/energy prices that might br manipulated

Question 8

terminology

hyperinflation

Answer 8

inflation that is out of control!

Question 9

creeping inflation

Answer 9

inflation that is presistently at 2 or 3% e.g inflation in EU in late 90’s

Question 10

uncertainty and growth

consequences of inflation

Answer 10

• uncertainty aboutt future prices
• discourages long-term investment
• growth is likely to be lowered

Question 11

Redistributes income

consequences of inflation

Answer 11

• borrowers benefit
• lenders lose
• people on fixed incomes lose
• people on profit incomes - raise their prices in line w/ inflation
• importers benefit
• exporters lose - worsenig the BoP

Question 12

resource costs

consequences of inflation

Answer 12

changing prices means new menues, price lists, price lable

Question 13

Fiscal drag

Answer 13

may push ppls incomes into a higher tax bracket in a progressive tax system

Question 14

erodes functions of money + price mechanism

consequences of inflation

Answer 14

1. commodity of exchange
2. means of deferred payment
3. store of wealth
4. unit of account
5. price mechanism - distorts resource allocation

Question 15

consequences of deflation

Answer 15

1. falling GDP & rising unemployment - can get stuck in deflationary trap
2. falling prices & expectations of lower future prices = delayed consumption at present = AD falls = prices fall even lower
3. business profits will fall - have to accept new price, unlikely to reduce costs
4. real debt values will increase
5. indebtedness discourages firms from making new investments
6. monetary policy (expansionary) becomes ineffective as a tool.
7. exports might becaome more competitive

Question 16

cost pull inflation

Question 17

Demand pull inflation

Answer 17

• caused by an increase in AD causing a rise in APL
• C & I might incrrease due to an optimistic and confident households or firms
• X might rise rapidly due to faster income growth in other countries
• G is often the cause of demand pull inflation - irresponsible overspending by governments or generous tax cuts.

Question 18

cost push inflation

Answer 18

• caused by a rising cost of production (stagflation)
• prices are rising and output is falling - unemployment is also rising
• illustrated by SRAS shift to the left
• caused by oil shocks, falling exchange rate, increase in indirect taxes

Question 19

combined DD pull and Cost push

Answer 19

results in a **wage price spiral **
- e.g. unions ask for higher wages, causing SRAS to move to the left - then AD is increased causing even higher prices = demand for further wage increases
- an increase in AD to combat slowing growth - causes APL to rise
- overall results in SRAS to shift left

Question 20

Solutions to Demand pull inflation

Answer 20

contractionary monetary or fiscal policy
- gov. would decrease its spending or raise taxes
- will decrease G + consumer consumption by decreasing disposible income
- raising interests - discourage I and C
- might encourage savings

• idea is to slow AD increases

Question 21

solution to cost push inflation

Answer 21

• supply side policies - aim to reduce costs of production & move SRAS to the right, lowers APL and higher level of real output