Inflation

Question 1

Causes of Inflation

Answer 1

Cost-push:

• Firms experience rising costs, so have to increase prices to stop their profit margin from decreasing
• Rising costs can be from increased price of commodities, increased indirect taxes, or high growth resulting in low unemployment and therefore increased labour costs (as workers have more bargaining power)
• If firms are importing raw materials from aboard, a falling exchange rate can also increase costs

Demand pull:
- Excessive aggregate demand in the economy means

An increase in the money supply also causes inflation

Question 2

Calculating Price Index =

Answer 2

Price (Year n) / Price (base year) x 100

Question 3

Costs of inflation

Answer 3

• If on fixed income, wages are unlikely to keep up with inflation, so become poorer in real terms.
• Decreased competitiveness unless inflation is accounted for by increased in exchange rate.
• Reduced investment as harder for businesses to predict future costs and revenues.
• Menu costs - firms have to constantly change price lists, tags, and catalogues, which is time consuming + expensive
• Leather costs - people don’t want to have lots of cash, as value will deteriorate, so have to make more trips to the bank, which has an opportunity cost of time
• Price signals can become blurred and so market system less effective.
• Value of savings can decrease if interest rate is below that of inflation, so can buy less good/services with these
• Wage-price spiral - workers see that there is high inflation and lobby for better wages to compensate for the increasing prices > increased costs for firms > even more cost-push inflation

Question 4

Inflation

Answer 4

A rise in the general price level

Question 5

Deflation

Answer 5

A fall in the general price level

Question 6

Disinflation

Answer 6

A fall in the inflation rate (however prices are still increasing even in a period of disinflation, just at a slower rate than before)

Question 7

Calculating inflation

Answer 7

Do a percentage change calculation

I.e. (New price level - Old price level) / Old price level
x 100

Question 8

Fisher Equation of Exchange

Answer 8

MV=PT
M - amount of money in circulation
V - velocity at which that money is circulating
P - average price level
T - number of transactions taking place

PT=AD

• Explains inflation due to an increase in the money supply because if you ^ M, for the same number of transactions, P will also increase.

Question 9

Hyperinflation

Answer 9

= Inflation at very high rates (usually anything over 100%) that is normally very unstable.

• Often caused by reckless printing of money
• Although UK does add to the monetary supply, we don’t end up with hyperinflation because it is done in a controlled way, through buying government bonds.

Question 10

UK inflation rate

Answer 10

0.6%

Question 11

Inflation rates to know

Answer 11

USA = 1.1%
Japan = -0.4% (deflation)
Greece = -0.9% (deflation)
China - 1.3% (used to be higher, disinflation has occurred as their economy is slowing down)
Russia - 6.9% (bc their exchange rate weakened massively, so have to increases prices to compensate)
Zimbabwe - -1.43% (used to be 2.7million% as had a period of hyperinflation due to reckless printing of money, but then switched to the dollar)