week 9 Flashcards
define inflation
Inflation refers to a sustained increase in the general or average price level
over time
The RBA’s goal of inflation .
This involves ensuring a stable purchasing power of the dollar
over goods and services.
➔
The RBA’s goal is to achieve low and stable inflation , also known
as price stability .
❖ The RBA’s inflation target is 2-3% on average over time .
define consumer price index
The Consumer Price Index (CPI) is a measure that tracks the average change in prices of a basket of goods and services typically purchased by households over time. It is used to calculate inflation
Why is some inflation (above 0%) considered beneficial for wage flexibility?
Because wages are often downwardly rigid—a small amount of inflation allows real wages to fall without cutting nominal wages, helping avoid unemployment during downturns.
How does inflation help adjust prices when quality improves?
Inflation may reflect quality improvements in goods and services. If quality increases 4% and inflation is 4%, the real cost of living remains stable.
What economic risks are associated with a 0% inflation target?
Zero inflation can cause low growth, higher unemployment, or even deflation, which can undermine economic stability.
define deflation
A decrease in the general price level of goods and services over time, meaning the inflation rate is negative. This can reduce consumer spending and lead to lower economic growth.
define disinflaiton
A decrease in the rate of inflation, meaning prices are still rising but at a slower rate than before. For example, if inflation drops from 5% to 2%, that is disinflation.
how is prolonged deflation harmful
Consumers delay purchases, reducing consumption &
production.
■ Leads to lower employment, incomes, and living standards.
■ Firms may delay investments, waiting for economic recovery.
Why Use Index Numbers to Calculate Inflation?
✅ Simplifies Comparisons: Allows economists to compare prices across different years using a base year (e.g., CPI = 100 in base year).
📈 Measures Cost of Living Changes: Shows how prices change for typical consumers.
⚖️ Adjusts Incomes & Contracts: Used to index wages, pensions, and government payments.
🧮 Standardised Measure: Provides a consistent method for calculating inflation.
calculate inflation
New CPI - old CPI divided by old CPI
(x 100)
denim headline inflation
Headline inflation measures the total change in the Consumer Price Index (CPI), including all items such as food and energy.
- Can be volatile due to fluctuating prices of food and fuel.
define underlying inflation
Underlying inflation measures the core inflation rate by removing volatile items (like food and fuel) from the CPI to reveal the long-term trend in price changes.
what are the three main measures of underlying inflation
trimmed mean
weighted median
CPI excluding volatile items
Trimmed Mean (Underlying Inflation Measure)
Removes the top 15% and bottom 15% of price changes to focus on the middle 70%, reducing the impact of extreme price shifts.
Purpose:
🔹 Highlights consistent inflation trends by filtering out outliers.
🔹 Commonly used by the RBA.
Weighted Median (Underlying Inflation Measure)
Identifies the price change at the 50th percentile, meaning half of the items have a higher inflation rate and half lower.
Captures the “central” movement of prices.
🔹 Minimises distortion from volatile items.
CPI Excluding Volatile Items
Removes highly volatile items like fruit, vegetables, and fuel from the Consumer Price Index.
-Purpose:
🔹 Focuses on stable price trends.
🔹 Offers a clearer view of core inflation unaffected by seasonal or temporary shocks.
what happens to the undelyifn rate and headline rate if volatile prices are rising
the underlying rate will be lower than
the headline rate.
what happens to the underlying rate and the headline rate if volatile prices are falling
the underlying rate will be higher
than the headline rate.
AD factors impact inflation
Higher disposable incomes
■ Lower interest rates
■ Stronger consumer and business confidence
■ A lower exchange rate, making imports more expensive
■ Stronger overseas growth leading to increased demand for exports
AS factors impacting inaction
Fewer or lower-quality factors of production (labor, raw materials)
■ Higher costs of production (e.g., higher wages or raw material costs)
■ Decreased technological progress or productivity
■ Adverse supply shocks (e.g., floods, oil price hikes, etc.)
■ A lower exchange rate leading to increased costs of imports
■ Excessive or burdensome regulations
Why Controlling Inflation Matters
High inflation slows growth, raises unemployment, erodes savings, reduces real incomes, and increases inequality. The RBA targets 2–3% inflation to support stability and confidence..
How does inflation erode purchasing power?
Inflation makes money buy less. Fixed-income earners and low-skilled workers are hit hardest. Real wages fall if income doesn’t rise with inflation. Even matched wage increases can trigger bracket creep, reducing real disposable income.
How does inflation distort the allocation of resources?
It shifts investment from productive areas (like business) to inflation-safe assets (gold, art). Consumers and producers misread price signals, making the market less efficient.
