Inflation

Question 1

Inflation

Answer 1

Inflation An ongoing increase in the general price level. An ongoing or persistent increase in the general price level from one time period to another e.g. 3% to 4%. An ongoing or persistent increase in the general price level or the average of prices across the economy from one time period to another e.g. 3% to 4%.

Question 2

Disinflation

Answer 2

A decrease in the rate of inflation due to changes in the general price level where more prices are dropping than rising resulting in a slow-down in the inflation rate.

Question 3

Deflation

Answer 3

Deflation A decrease in the general price level where prices on average have dropped e.g. -1% to -2%. A decrease in the general price level where prices are dropping on average so the price level falls from -1% to -2%. A decrease in the general price level due to changes in the consumer price index where prices are dropping on average so the price level falls from -1% to -2%.

Question 4

Consumer price index

Answer 4

An index that monitors the prices of 700 goods and services purchased across the country in mainly urban areas by an average household to determine the rate of inflation in the economy that affects consumers/households.

Question 5

Real values / Real GDP

Answer 5

Real values are adjusted for the changes in the general price level so the value is adjusted to remove the inflation so it is more useful in analysis. E.g. GDP shows the actual change in quantity produced rather than price increases and quantity.

Question 6

Nominal values / Nominal GDP

Answer 6

Nominal values are taken at current or today’s prices which can be distorted by inflationary pressures and ongoing inflation occurring during a recovery or boom time period. GDP at nominal levels is an estimate of the output of the nation but is not a good indicator to compare across the years due to the inflation included in the value.

Question 7

General price level

Answer 7

Average of all prices across the economy that considers if the majority of prices rise remain stable or drop which can determine if inflation is occurring in the economy and the rate of inflation.

Question 8

Price rises in one product market

Answer 8

When one product e.g. kumara changes price that is not inflation but only the price increase of one good. Some goods though can influence prices of other goods and can generate inflation e.g. oil, electricity, petrol or insurance etc.

Question 9

Quantity theory of money
(MV=PQ)

Answer 9

A theory that shows that a relationship exists between the Money supply and how quickly it is spent and the total production of the economy and the price level.
Money supply moves in proportion to the Price level assuming V and Q are constant.

Question 10

Money supply

Answer 10

Money supply is all the $ in circulation including deposits, term deposits, savings accounts and everyday accounts. Money supply changes as a result of interest changes, availability of credit/ borrowing, reserves required to be held by the banks or even new X receipts.

Question 11

Velocity

Answer 11

Velocity is the speed in which money is spent within the economy. Velocity can be considered constant as people usually follow similar spending habits, but in some instances it can change due to consumer confidence, access to credit /borrowing or interest rates. If V increases P increases (assuming M and Q are constant) so proportional M ὰ P.

Question 12

Price level

Answer 12

The price level represents the average of prices determined by the General price level. This is used as an indicator of Inflation which can be caused by Demand pull or Cost push inflation. So any increase in Pl will have an equal or proportionate change in MV.

Question 13

Real output

Answer 13

Real Output represents the total production of the country at a national level, not just one business. It is the total production or national supply. When output increases due to factors that are favourable i.e. unutilised resources being used in the production process, during a recovery period as a result of a slowdown in recession or depression moving to more confidence, production increases Q increases, so a proportional increase in MV will occur.

Question 14

Purchasing power

Answer 14

Inflation will reduce the purchasing power or real income of people who are buying goods and services. As inflation increases as GPL rises, the income will purchase less in real terms i.e. less goods and services - so the standard of living will fall of people who cannot increase income as inflation rises.

Question 15

Proportionate change

Answer 15

MV=PQ Whatever happens to one side the other side will move in equal proportion. E.g. If MV doubles then PQ will double to maintain the balance.

Question 16

AD/AS model

Answer 16

A model that shows the National demand and National supply of the country and the actual production level of the country and price level that occurs with that current output.

Question 17

Aggregate demand

Answer 17

The National Demand of a country that divides the economy into sectors and the spending of each sector is added together to give the national GDP or AD at each price level.

Question 18

Aggregate supply

Answer 18

The National Supply of the country that includes all production from all industries across the economy, including services and supply of goods at each price level.

Question 19

Consumption spending

Answer 19

Consumption spending is the income spent on goods and services by households. This can be influenced by immigration, consumer confidence, income levels, interest rates and inflationary expectations.

Question 20

Investment

Answer 20

Investment is the purchase of capital goods by producers to increase the production of a business across the nation including the replacement of old machines and new projects.

Question 21

Government spending

Answer 21

Government spending from the government on infrastructure, social spending, health and education. When the government spends more than it taxes, it causes an increase in AD as a Budget deficit occurs T < GS which can cause PL to rise. If T=GS then AD remains the same.

Question 22

Net Exports

Answer 22

Net exports is income received from the overseas sector that is re-spent within the NZ economy. Export receipts less import payments (the increase to the economy of new money flowing in). Export receipts are usually spent on wages and other expenditure for the business that exports.

Question 23

Demand Pull inflation

Answer 23

Demand pull inflation results from any increase in the components of Aggregate demand such as C + I + G + (X- M).

Question 24

Cost push inflation

Answer 24

Cost push inflation results from an increase in the COP or productivity that results in a decrease in the Aggregate supply curve.

Question 25

Productivity

Answer 25

The speed of production that can turn inputs (raw materials) into outputs (products or services). When productivity increases AS increases as more can be supplied to the market as production increases. If Productivity increases GDP increases but the inflation rate will slow down (disinflation). If productivity gets worse, AS will decrease as less is produced and the price level will rise so inflation increases and output /GDP drops.

Question 26

Cost of raw materials

Answer 26

The cost of producing a product based on the required materials that will be used in the production process. As these costs increase Aggregate supply will decrease causing a shift left and a decrease in GDP and PL increases.

Question 27

Minimum wage or wage rates

Answer 27

The minimum wage rate is paid by producers to household workers as the lowest possible rate i.e. $15.75. Any governmental changes in MW will impact on COP and therefore the National Aggregate supply. If on 1 April MW increases, then COP Increases, so Aggregate Supply decreases (shifts left) PL increases as GDP drops as less production occurs due to added costs.

Question 28

Exchange rates

Answer 28

The Exchange rate is the tool used to exchange the currency of one country with another so that conversions can be made of money i.e. from US$ to NZ$. The Exchange rate is determined by the equilibrium of DNZ$ and SNZ$.

Question 29

Deprecation of ER

Answer 29

A depreciation of the exchange rate will impact on exports and imports as the overseas currency will be used to purchase goods and be received for sales of goods sold abroad. When the EX rate drops, export receipts become higher as goods and services become more competitive abroad and sell more easily. Import payments however become more expensive to make so costs like COP and AS is affected and overall x-m will improve. AD increases and AS decreases.

Question 30

Appreciation of ER

Answer 30

An appreciation of the exchange rate will impact on exports and imports as overseas currency will be used to purchase goods and be received for sales of goods sold abroad. When the EX rate rises, export receipts drop as goods and services become less competitive abroad and sales are harder. Import payments however become less expensive to make so costs like COP and AS are affected and overall x-m will decrease. AD decreases and AS increases.

Question 31

Business cycle

Answer 31

A model that shows the changes in GDP over time as the economy moves through the different stages of the cycle. As investment and spending changes over time the economy moves through the cycle impacting on inflation and employment

Question 32

Boom or Peak

Answer 32

A stage of the business cycle where GDP is at its highest and Inflationary pressure will be high as production is strong and resources are being used up. As resources become scarcer for production the cost of accessing raw materials pushes up the price level. The economy is likely to be operating at full capacity or close to productive capacity.

Question 33

Downturn or recession

Answer 33

A stage of the business cycle where GDP is falling and inflationary pressure is dropping as production is slowing down. Less resources are used and resources become idle. The economy has unemployment and idle capital goods not used in the production process and inflation is falling i.e. disinflation is likely to be happening. Investment will be falling along with consumption and other components of GDP.

Question 34

Depression or trough

Answer 34

A stage of the business cycle where GDP has reached its lowest point and inflationary pressure may be slowing to deflationary risks. Production and employment is at its lowest point and unemployment and idle capital is at its greatest level. Investment has stalled and consumption spending has been affected by falling incomes and low production so GDP levels off.

Question 34

Recovery or upturn

Answer 34

A stage of the business cycle that shows GDP starting to rise as consumer and producer confidence starts to rise and this leads to more purchases of goods and services. Production increases which causes GDP to rise and investment to rise. Pressure on the general price level to begins, which leads to inflation starting to increase.

Question 35

Impacts on firms of inflation Difficulty planning

Answer 35

The firms will struggle to price products as raw materials prices changes frequently and therefore selling prices will have to change often. Planning for the future becomes difficult as it becomes harder to judge the sales of your business if prices are rising too much and QD is affected.

Question 36

Impacts on firms of inflation Less investment in capital goods

Answer 36

When a business is unsure of its sales and potential profits it will be less willing to borrow large amounts of money and will not invest in capital goods /machinery when inflation is rising and becoming a problem for the economy. Constant or stable inflation is better so firms will invest for the future.

Question 37

Impacts on firms of inflation Speculative investment vs productive investment

Answer 37

Speculative investment is buying currency or property on the expectation that the value will rise and a profit will be made. Productive investment is putting money into a business that makes or creates jobs for the economy that can lead to increased GDP.

Question 38

Impacts on households of inflation Savings

Answer 38

Savings is not encouraged as any money in the bank will lose purchasing power over time, so savings will fall with inflation. Though interest rates may rise to combat the inflation, it must be greater that inflation to prevent lost purchasing power of money and people choose to spend rather than save as goods are expected to cost more in the future they now and prevent paying a higher price later.

Question 39

Impacts on households of inflation Borrowing

Answer 39

Borrowing money from banks can be a benefit for a household or producer as the debt will also lose purchasing power and over time will become lower in real terms and easier to service as incomes should rise.

Question 40

Impacts on households of inflation Incomes – fixed vs high income earners

Answer 40

People on a fixed income will find the income they receive will not purchases as many goods and services and therefore their standard of living will fall. A person with high qualifications and skills in demand can ask for pay rises to compensate for inflationary pressure or loss of purchasing power.

Question 41

Impacts on households of inflation Wealth

Answer 41

Poorer people tend to spend all their wages and therefore will be affected most by rising prices of goods and services. Richer people can put money into artwork, property or shares that may not be affected by inflation as much.

Question 42

Impacts on households of inflation Fiscal drag

Answer 42

Fiscal drag is when a person increases their income as a result of a pay rise to compensate for inflation which then pushes them into a higher tax bracket and they pay more in tax. This can mean they are worse off in the long term, as their disposable income ($ after tax) is lower than it was before.

Question 43

Impacts on households of inflation Inflationary expectations

Answer 43

Expectations of inflation can influence people to change their spending behavior. If inflation is expected people may purchase larger items now rather than later to avoid paying more for them later if the prices are expected to rise. When deflation is occurring the opposite occurs as people put off buying goods and services hoping the price will drop so this slows the economy and causes the price level to drop causing disinflation and later deflation.

Question 44

Impacts on households of inflation Wage spiral

Answer 44

As inflation occurs workers request a pay rise to compensate for lost purchasing power which causes costs of production to rise so AS decreases and AD increases which causes a larger change in inflation but little change in production (GDP). So a rise is expected to compensate for inflation resulting in AS and AD again to change causing ongoing inflation problems with little growth.

Question 45

Impacts on households of inflation Economic growth

Answer 45

Economic growth will increase GDP which usually will cause problems for pressure on inflation. As demand for goods and services pushes up prices AD increases. Or, production uses resources which become scarce and prices rise for them. AS decreases. Either way the price level will rise as inflation increases when economic growth occurs.

Question 46

Impacts on households of inflation Trade

Answer 46

Trade will increase GDP which will cause X-M to increase AD increases so Inflation will increase as a result of the shift right of AD.

Question 47

Impacts on households of inflation Employment

Answer 47

Employment will increase if GDP increases which will increase the employment or use of capital goods to increase the production. More employment could impact on inflation as people have more money to spend on goods and services resulting in inflation.