macro- inflation and deflation

Question 1

define inflation

Answer 1

state of sustained increase of general price level in an economy

Question 2

two types of inflation

Answer 2

Demand-pull inflation and Cost-push inflation

Question 3

define cost-push inflation

Answer 3

when inflation arises due to issues in the supply-side of economy
= can occur due to the increased union power in wage bargaining process= increases supply costs
= usually causes short-run aggregate supply to shift to the left
= due to increased costs of production
= creating inflation

Question 4

define demand-pull inflation

Answer 4

when inflation is caused by excessive aggregate demand
= means that aggregate demand is rapidly increasing, faster than the long-run aggregate supply of the economy
= creating inflation

Question 5

ways to measure inflation

Answer 5

Retail price index (RPI) and the Consumer price index (CPI)

Question 6

describe CPI

Answer 6

Currently, gov uses CPI= similar to RPI but doesn’t include mortgage interest repayments
- government records expenditures of the ‘national shopping basket’= consists of 700 or more goods people consume on daily basis
- calculated % change in price
- represented as an index number

Question 7

define deflation

Answer 7

prices of goods and services in an economy are falling
= general fall in the price level in the economy

Question 8

causes of demand-pull inflation

Answer 8

• increase in aggregate demand= prices of products and services will increase to stimulate firms to produce more output in response to growing demand
• positive output gap is another cause of demand-pull inflation= means that the growth rate of the economy is above the trend growth rate= leads to higher inflation

Question 9

causes of cost-push inflation

Answer 9

-caused by the growing monopoly power of trade unions= as unions become more powerful they demand higher wages= raises cost of labour= raising costs of production for a firm
- can be caused by increased commodity or energy prices= raises the overall cost of production= causing the short-run aggregate supply to shift to the left

Question 10

define stagflation

Answer 10

a period of slow economic growth, rising unemployment, and also rising inflation

Question 11

What causes deflation

Answer 11

• shortages or falling of the money supply
• decrease in the velocity of money circulation
• fall in aggregate demand
• increase in productivity

Question 12

effect of decrease aggregate demand

Answer 12

causes a fall in consumer confidence= a fall in spending= causes the general price level to fall= Firms may then react to this by decreasing wages to lower their costs of production= Lower wages will feed into lower households’ income= causing their demand to fall further= referred to as a deflation spiral

Question 13

define deflation spiral

Answer 13

occurs when deflation affects the circular flow of income in a way that deflation in itself becomes a self-reinforcing loop

Question 14

effect of increase in productivity

Answer 14

can be influenced by improvements in technology= reduce costs of production= causing the aggregate supply to shift to the left and lower the overall price level in the economy

Question 15

adv of inflation on individuals

Answer 15

• Inflation is favourable for consumers that have loans= debt repayments stay at same level= makes them decrease in value= makes it easier for consumers to repay their debts
• workers can bargain income increas

Question 16

disadv of inflation on individuals

Answer 16

• Decrease in consumers’ purchasing power due to the increased prices of goods and services
• Due to inflation, businesses have to pay higher wages to their employees= to reduce costs of labour, businesses may make cuts in employees by making them redundant
• High and unstable inflation affects agents’ expectation formation about future price levels= affects the economy in an unpredictable way
• erodes savings= interest rates don’t increase in line with inflation= less likely to be able to buy houses
• fiscal drag

Question 17

adv of inflation on firms

Answer 17

• firms can encourage increase output= increase revenue
• improve gov finances

Question 18

disadv of inflation on firms

Answer 18

• lower export competitiveness
• risk of wage price spiral= increase production costs
• inflationary noise= price signalling becomes less significant

Question 19

consequences of deflation

Answer 19

• In long run, consumer spending declines= as prices are decreasing, consumers are likely to hold on to their savings, as in the future they believe that the costs of goods will be even lower
• consumer salaries will decrease simultaneously.
• decline in business productivity due to lower demand for consumer goods= results in an increase in unemployment as businesses won’t need to supply as many goods
• price mechanisms are disrupted= makes people confused about true value of products and services= affects their expectation formation about future price levels
• causes overall slowdown in economy