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A Level Economics: Macroeconomics > 11.3 Inflation And Deflation > Flashcards

11.3 Inflation And Deflation Flashcards

1
Q

What is inflation?

A

A persistent or continuous rise in price level or as the continuing fall in price level the value of money to rise

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2
Q

What was the rate of inflation in 1980?

A

20%

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3
Q

What was the inflation rate in 1990?

A

10%

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4
Q

What does deflationary policy involve?

A

Fiscal or monetary policy to reduce aggregate demand and levels of economic activity,output and unemployment

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5
Q

What are the two types of inflation

A

Cost push
Demand pull

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6
Q

What is demand-pull inflation?

A

(Demand inflation)

A rising price level caused by an increase in AD shown by a shift of AD to the right

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7
Q

What is cost push inflation

A

( cost inflation)

A rising price level caused by an increase in the costs of production, shown by a shift in the SRAS curve to the left

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8
Q

What is demand pull inflation caused by

A

Increase in AD

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9
Q

What does to the left of the LRAS curve mean?

A

Producing below the normal capacity of output

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10
Q

What happens when the economy is initially producing the on the economies SRAS curve but below the normal capacity level of output?

A

The price level has to rise to persuade firms to produce more output to meet the extra demand

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11
Q

What can lead to demand pull inflation?

A

An increase in any of the components of AD
-consumption
-investment
-government spending
-export deficit

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12
Q

Diagram for demand-pull inflation

A
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13
Q

Describe how this diagram shows demand-pull inflation

A

-equilibrium national income is at point X
-the initial point of AD is AD1
-shift to AD2 causes price level to rise to p2
-real national income Increases to normal carport level of Yn

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14
Q

What does this diagram imply

A

-economy producing below normal capacity level of output and then moving to a normal

  • capita of output

-following increase in AD equilibrium point becomes Z with economy on LRAS curve

-any shift past z results in demand pull inflation

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15
Q

What it be inflationary to increase AD from point V

A

Would increase output and employment and a little effect on inflation

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16
Q

What is the cause of cost push inflation

A

Structural and institutional conditions on the supply side of the economy particularly in the labour market and the wage-bargaining process

(Wage-cost inflation)

-rising prices of energy/ commodities can also cause cost push inflation (import-cost inflation)

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17
Q

What do cost push theories generally argue?

A

The growth of monopoly power in the economy’s labour market and in its market for goods and services is responsible for inflation

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18
Q

Diagram for cost push inflation

A
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19
Q

Describe how the diagram shows cost push inflation

A

X=equilibrium national Income
Real output=y1
Price level=p1

Money costs of production that firms incur rise because money wages or the price of imported raw materials rise, increases production costs and SRAS shifts left

Shift left cusses price level to rise to p2, the amount of output firms are willing to produce decreases to y2 from y1, new point of z

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20
Q

What is easier to fix cost push or demand pill

A

Demand pull

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21
Q

What can be done to fix cost push inflation

A

Reduce inflation target
Reduce vat and subsides to firms

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22
Q

Who are monetarists?

A

Economists who argue that a prior increases in the money supply is the caused of inflation

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23
Q

What is monetarism?

A

Narrow monetarism centres on increases in the money supply as the prime cause of inflation. Broader monetarism focuses on the virtues of free markets in resource allocation

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24
Q

Free market economists are known as?

A

Monetarists

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25
Q

Monetarists subscribe to the theory of ….

A

Demand-pull inflation but go a stage further by arguing that excess AD for output is caused by a prior increase in money supply

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26
Q

What is monetarist economic theory known as?

A

Monetarism

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27
Q

What theory lies at the heart of the monetarists theory of inflation?

A

The quantitive theory of money

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28
Q

What is the quantitative theory of money?

A

Oldest theory of inflation, states inflation is caused by a persistent increase in the supply of money

29
Q

According to the quantity theory of money, what happens when expansion of money supply is greater than the increase in real national income?

A

Households and firms have excess money which when spent drive up the price level (too much money chasing too few goods)

30
Q

What is the equation of exchange

A

Money supply(stock of money) x the velocity of three circulation of money= price level x quantity of output

MV=PQ

31
Q

What is the velocity of circulation?

A

Speed of which money circulated around the economy when people use money to buy goods

32
Q

What does it mean when monetarists argue that v is constant or stable?

A

When M increases, it is spent on services, if Q is unable to increase the price level (P) is pulled up by excess demand

33
Q

What do Keynesian economists believe when M increases?

A

It may be partially absorbed by a showdown in , which means the much of the extra money is not spent on customer goods and services

The PQ on the right hand side of the equation can increase either because real output increases or the price level increases

34
Q

What is the equation of exchange written as and what does T stand for?

A

MV=PT

T stands for total transactions taking place in the economy

-comes from American economist Irving Fisher

35
Q

Why is PQ a better measure of PT for expenditure on national output?

A

Because total transactions include second-hand transactions as well as the exchange of new goods and services

36
Q

What do Keynesian economists think about the quantity theory of money as an explanation of inflation

A

They reject it

37
Q

What are the three main ways Keynesian economics have attacked the quantity theory

A

-the velocity of circulation is not constant
-under-full employment equilibrium
-reverse causation

38
Q

Why do Keynesian Economists attack the quality theory of money with under-full employment equilibrium?

A

-if there is spare capacity and unemployment in the economy, an increase in the money supply may increase real outcome and output rather than the price level P

-market forces are too weak and take too long to return the economy to its normal capacity output, the economy can get stuck in an under-full employment equilibrium

39
Q

Why do Keynesian Economists attack the quality theory of money with the velocity of circulation is not constant?

A

-question wether the velocity of the circulation of money is constant(v represents how often money is spent)

Monetarists believe that money earns little or no interest should spent it straight away

Keynesian argue under certain circumstances (when share and bond prices are expected to fall) it it sensible to hold idle money balance

40
Q

What is inflation?

A

Sustained rise in an economy’s general price level

41
Q

What is hyperinflation?

A

Phase of extremely rapid inflation nearly always with he result of mass Monet printing by the government with money as an asset ending up as worthless

42
Q

Why do Keynesian Economists attack the quality theory of money with reverse causation?

A

If a gov tightly restricts the growth of money to try and stem inflation, the main effect might be that the current level of transactions cannot be financed, so real activity will fall

43
Q

Deflation

A

A sustained period when the vernal price level for goods and services is falling

44
Q

Can people’s expectations of future inflation affect current inflation rates?

A

Yeah

45
Q

Who was the leading Monetarist who found that people’s expectations of future inflation affect current inflation rates

A

Milton Friedman

46
Q

What is disinflation

A

Fall in rate of inflation but not sufficient to bring about price inflation

47
Q

How can future inflation expectations affect current inflation

A

Because people will react in an inflationary way now

48
Q

Who benefits from inflation

A

Home owners
Government (debt decreases)

49
Q

What are the two theories of future expectations of inflation

A

Adaptive expectations
Theory of rational expenses

50
Q

What is creeping inflation

A

When inflation is low year on year and easy to predict

51
Q

Why is a low but stable inflation rate important for labour markets to run efficiently?

A

When prices are completely stable, to cut real wage rates nominal wage rates have to fall

With 0 inflation the changes required in relative wage rates needed to make labour markets function efficiently fails to take place

52
Q

What does inflation lead to(6)

A

-risk of wage inflation
-falling real incomes
-inequality (affects poorer people more)

-higher cost of borrowing
-business uncertainly
-less business competitiveness

53
Q

What are the effects of inflation?

A

-disproportionate effects
-distortion of normal economic behaviour
-breakdown of functions of money
-reduced international uncompetitiveness

54
Q

How does inflation have disproportionate effects?

A

Weaker social groups on fixed incomes lose out

55
Q

How does inflation distort the normal economic behaviour?

A

Distorts consumer behaviour causes households to bring forward purchases if they expect the rate of infection to accelerate

56
Q

How does inflation cause the breakdown in the functions of money?

A

Money becomes less useful and efficient as a medium of exchange and store of value

57
Q

How does inflation lead to reduced international uncompetitiveness

A

When inflation is higher than in competitive countries exports increase in price ,putting pressure on fixed exchange rate

Lower growth and rising unemployment are likely to result

58
Q

Who benefits from inflation?

A

Workers with strong wage bargaining power

Debtors if real interest rates are negative

Producers if prices rise faster than costs

59
Q

What is the triple lock?

A

Rate at which the pensioners incomes go up each year

60
Q

What is extended deflation an issue?

A

When people believe prices are going to fall they postpone big spending decisions

61
Q

Diagram for ‘good’ deflation

A
62
Q

Diagram for ‘bad’ deflation

A
63
Q

Describe this diagram

(Good deflation)

A

Results in improvement in economies supply side reduces business cost and costs In production so price level falls but employment and output rises

64
Q

Describe this diagram

Bad inflation

A

Reduced AD has negative multiplier effects and possibly a credit crunch

65
Q

How do changes In other countries affect UK inflation?

A

When times are good in world economy with rising demand for commodities UK imports inflation

When times are bad the pressure on UK inflation is reduced

66
Q

What does a fall in the pounds exchange rate to other currencies lead to

A

Cost-push inflation

67
Q

Which two countries affect the the UK price level the most?

A

USA
China

68
Q

What is the final thing that can affect UK inflation rates

A

Supply and demand unforeseen shocks

69
Q

What do the economic effects on inflation depend on?

A

-if high inflation is temporary or persistent

-wage bargaining power of workers in different industries

-whether nominal interest rates on savings and loans keep pace with inflation

-does uncertainty lead to a fall in domestic and foreign inward investment

-extent to which a central bank is prepared to tolerate inflation without raising interest rates

A Level Economics: Macroeconomics (25 decks)

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