LS8 - Inflation

Question 1

Inflation

Answer 1

A sustained increase in the general level of prices one a period of time (leading to a fall in the purchasing power of money).

Question 2

Deflation

Answer 2

General decrease in the price level over time.

Question 3

Disinflation

Answer 3

Reduction in the rate of inflation e.g. from 3% to 2% so it’s still positive.

Question 4

Hyperinflation

Answer 4

Very high and usually accelerating rates of inflation, rapidly eroding the real value of the local currency.

Question 5

Objective Of Inflation

Answer 5

To have price stability i.e. low and stable inflation which happens when prices don’t change.

Question 6

CPI

Answer 6

A weighted price index which measures the change in the prices of goods and services (UK).

Question 7

Calculation CPI

Answer 7

The ONS find the typical goods bought by households and use it to decide how to weigh each category of goods and services based on its importance to the budget, calculate the increase to the price index through finding the weighted average change and then use the price index to calculate the inflation.

Question 8

CPI Equation

Answer 8

(Current Year Index - Previous Year Index)/Previous Year Index

Question 9

Difficulties In Measuring Inflation

Answer 9

Basket may not be representative making it difficult to judge a typical household.
New technology entering the market makes it difficult to calculate a change in price.
Doesn’t take into account increasing quality with price.
Sampling errors.

Question 10

Consequences Of Inflation

Answer 10

Redistribution Effects 
Uncertainty 
Menu Costs 
Money Illusion 
International (Export) Competitiveness

Question 11

Redistribution Effects

Answer 11

Inflation redistributes income away from certain groups and towards others, some groups lose some purchasing power whilst others gain purchasing power e.g. holders of cash lose purchasing power and borrowers may be paying lower interest rates so benefit.

Question 12

Uncertainty

Answer 12

It doesn’t allow people to accurately make economic decision as they don’t know what will happen to their purchasing power, resulting in fewer investments and less economic growth.

Question 13

Menu Costs

Answer 13

Firms like restaurants have to print new menus to align with current inflation as they have to increase their prices.

Question 14

Money Illusion

Answer 14

Some people think they’re better off when their nominal wages increase, despite an increase in the general price level meaning they’re worse off.

Question 15

International (Export) Competitiveness

Answer 15

When the price level in certain countries increase quicker than others, exports become more expensive to foreigners and imports become cheaper meaning exports fall whilst imports rise.

Question 16

Cost-Push Inflation

Answer 16

Changes to the supply side of the economy leading to rising costs e.g. production costs increasing meaning firms have to increase prices to maintain profit margins.

Question 17

Demand-Pull Inflation

Answer 17

Increasing AD outstripping AS, therefore causing a rise in prices e.g. a surge in demand for oil without a high supply of oil causing oil prices to significantly increase.

Question 18

Factors Causing AD To Increase

Answer 18

Depreciation Of The Exchange Rate.
Higher AD From A Fiscal Stimulus e.g. reduction in taxation.
Monetary Stimulus To The Economy e.g. reduction in interest rates and increase in investment.
Faster economic growth than other countries, a boost to UK exports and therefore a boost in spending and consumption.

Question 19

Wage Price Spiral Example

Answer 19

Increase in oil prices leads to an increase in firms’ production costs, leading to a rise in firms’ prices, leading to an increase in the general price level, meaning workers demand higher pay rises, Because there has been a fall in real income, This leads to an increase in firms costs of production, This means that firms must increase prices to maintain profits which is a wage-price spiral.

Question 20

Hyperinflation

Answer 20

When Prices rise so rapidly that the value of money becomes worthless.

Question 21

Causes Of Hyperinflation

Answer 21

Citizens Not Buying Bonds

Panic Buying

Question 22

Citizens Not Buying Bonds

Answer 22

When citizens and foreigners won’t buy bonds and raising taxes isn’t enough forcing the bank to print more currency and the government then spends this money into the economic.

Question 23

Panic Buying

Answer 23

Once high inflation is expected, consumers bring forward their purchases and firms will raise prices and workers will demand higher wages.

Question 24

Deflation

Answer 24

A sustained fall in the general price level over a period of time.

Question 25

Consequences Of Deflation

Answer 25

Lower Profits
Real Wage Unemployments
Deflationary Spiral

Question 26

Lower Profits

Answer 26

Company profits will be squeezed leading to unemployment as firms reduce costs.

Question 27

Real Wage Unemployment

Answer 27

Workers resist nominal wage cuts therefore during deflation real wages rise leading to higher production costs and firms reducing the workforce.

Question 28

Deflationary Spiral

Answer 28

Consumers and firms may delay spending money reducing AD, lowering prices and output overall, reducing consumer and business confidence alongside government policies.

Question 29

Benefits Of Deflation

Answer 29

Increased Efficiency

International Competitiveness

Question 30

Increased efficiency

Answer 30

Deflation from increased efficiency and lower costs of products cause the AS to shift to the right lowering price levels and increasing real GDP.

Question 31

Solving Demand Pull Inflation

Answer 31

Fiscal and monetary policies will be used to reduce AD.

Question 32

Solving Cost Push Inflation

Answer 32

The government will try to reduce production costs.

Question 33

Supply Side Policies

Answer 33

Increase productive capacity and help address inflation.

Question 34

Inflation Targeting

Answer 34

Convinces people inflation is under control, meaning consumers will not bring forward purchases, workers may press for lower wage prices and firms may not push their prices just to cover expected higher costs, this prevents a wage-price spiral.