inflation + use of interest rates Flashcards
(14 cards)
What is inflation?
A sustained increase in the average price level of goods and services in an economy.
What are the two main causes of inflation?
Demand-pull inflation and cost-push inflation.
What causes demand-pull inflation?
Excess aggregate demand (AD = C + I + G + (X - M)), where demand outstrips supply, leading firms to raise prices.
How does demand-pull inflation occur according to AD/AS diagrams?
An outward shift of AD causes prices to rise from P1 to P2 due to scarcity and profit incentives, increasing inflation.
What causes cost-push inflation?
An increase in production costs (e.g. wages, raw materials) or a fall in productivity, shifting SRAS or LRAS leftward.
How do rising costs lead to cost-push inflation?
Firms pass higher input costs onto consumers, raising prices and reducing real output.
What is stagflation?
A period of economic slowdown with low growth, high unemployment, and high inflation simultaneously.
Name one social cost of inflation.
It increases poverty and inequality by reducing the real value of fixed incomes like pensions.
How does inflation affect purchasing power?
It erodes the value of money, reducing how much goods and services consumers can buy.
How does inflation impact international competitiveness?
UK exports become more expensive, reducing demand and worsening the trade balance.
How does inflation affect investment?
Uncertainty over future prices discourages investment and delays capital spending.
What are menu costs?
Administrative costs incurred by firms when they frequently change prices due to inflation.
How do high interest rates reduce demand-pull inflation?
They increase the cost of borrowing and reward saving, reducing consumption and investment, thus lowering AD.
How do low interest rates influence inflation?
They reduce borrowing costs and discourage saving, increasing consumption and investment, potentially causing demand-pull inflation.
