Inflation

Question 1

What is inflation

Answer 1

A sustained increase in the cost of living or the general price level leading to a fall in the purchasing power of money

Question 2

How is the rate of inflation measured

Answer 2

Annual % change in consumer prices

Question 3

What is the uk government’s inflation target

Answer 3

2%

Question 4

Who helps control inflation rates

Answer 4

The Bank of England sets monetary policy interest rates so that inflationary pressures are controlled and the inflation target is reached

Question 5

What is deflation

Answer 5

Rate of inflation is negative

Question 6

What is disinflation

Answer 6

Fall in the rate of inflation

Question 7

What is hyper-inflation

Answer 7

A period of very high rates of inflation, usually leading to a loss of confidence in an economy’s currency

Question 8

What is the inflation rate

Answer 8

The annual rate of change of the average price of goods and services

Question 9

What are unit labour costs

Answer 9

They reflect labour costs, including social security and employers’ pension contributions, and including the costs of self-employed labour, incurred in the production of s unit of economic output

Question 10

What is the consumer price index

Answer 10

A measure of the price level based on the prices of a collection of products designed to reflect the consumption basket of the average consumer

Question 11

How is the rate of inflation calculated (CPI)

Answer 11

• a base year is selected and an expenditure survey carried out
• basket of goods (weights attached to each item based on their importance)
• weights are multiplied by brand changes

Question 12

How many people do they base year survey for CPI

Answer 12

40,000

Question 13

How do you calculate the price index for a year

Answer 13

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

Question 14

Limitations of the CPI as a measure of inflation

Answer 14

• not representative of ‘non-typical’ households
• some people have different spending patterns
• changing quality of goods and services
• new produced each year

Question 15

What changes yearly with the CPI

Answer 15

The basket of goods - to represent changes in preferences and needs

Question 16

CPI rates U.K.

Answer 16

Increasing over time

Question 17

What are the main causes of inflation

Answer 17

• demand and supply sides

- internal and external events

Question 18

Internal and external causes of inflation

Answer 18

• domestic economy (e.g. rise in VAT)

- external sources (e.g. rise in commodities)

Question 19

When does demand pull inflation occur

Answer 19

When aggregate demand is growing at an unsustainable rate = increased pressure on scarce resources and a positive output gap

Question 20

When does demand pull inflation become a threat

Answer 20

When an economy has experienced a boom with GDP rising faster than the long-run trend growth of potential GDP

Question 21

When is demand pull inflation likely to occur

Answer 21

When there is full employment of resources and SRAS is inelastic

Question 22

What are the main causes of demand pull inflation

Answer 22

• depreciation of the XR
• higher demand from fiscal stimulus
• monetary stimulus
• fast growth in other countries

Question 23

How does a depreciation of the XR create demand pull inflation

Answer 23

Increases the price of exports and reduced the foreign price of a country’s exports. If consumers buy fewer imports, while exports grow, AD in will rise - and there may be a multiplier effect on the level of demand and output

Question 24

When does cost-push inflation occur

Answer 24

When businesses respond to rising costs, by increasing pricing to protect their profit margins

Question 25

Why might costs for businesses rise (causing cost-push inflation)

Answer 25

- component costs - rising labour costs - expectations of inflation - higher indirect taxes - fall in the XR - monopoly employers / profit-push inflation

Question 26

Expectations of inflation

Answer 26

- difficult to remove once established - most people will raise their inflation expectations and build it into their decisions - increase in inflation expectations

Question 27

What are internal causes of inflation

Answer 27

- surge in property prices - higher wages / cost of labour - book in credit / money supply - rise in business taxes

Question 28

What are the external causes of inflation

Answer 28

- increase in world oil / gas prices - inflation in global commodity prices - depreciation of the XR - high inflation in other countries

Question 29

Consequences of inflation for consumers, business, the government and workers

Answer 29

- income redistribution - falling real income - negative real interest rates - cost of borrowing - risks of wage inflation - business competitiveness - business uncertainty

Question 30

Winners of inflation

Answer 30

- workers with strong wage bargaining power - senators if real interest rates are negative - producers if prices rise faster than costs

Question 31

Losers of high inflation

Answer 31

- retired on fixed incomes - lenders if real interest rates are negative - savers if real returns are negative - workers in low paid jobs

Question 32

Why is the rate of inflation difficult to forecast accurately

Answer 32

- volatile global energy prices - changes in value of the currency - uncertain growth of AD - volatile food prices - government indirect taxes can change

Question 33

How can inflation be reduced

Answer 33

Policies that slow AD or boost AS

Question 34

How can fiscal policy help reduce inflation

Answer 34

Tighten fiscal policy - reducing spending on public and merit goods or welfare payments - raise direct taxes

Question 35

How can monetary policy reduce inflation

Answer 35

Tightening of monetary policy -higher interest rates (May cause the XR to appreciate in value)

Question 36

How can supply side policies reduce inflation

Answer 36

Increase productivity, competition and innovation - all of which maintain lower prices

Question 37

How can direct controls reduce inflation

Answer 37

Controls on some prices and wages

Question 38

What is the best way to control inflation in the short term

Answer 38

For the government and the central bank to keep control of AD to a level consistent with out productive capacity

Question 39

When is controlling demand to limit inflation likely to be ineffective in the short run

Answer 39

If the main causes are due to external shocks such as high world good and energy prices