11.3 Inflation and deflation Flashcards
What are the two types of Inflation
Demand pull inflation and cost push inflation
what is the definition of inflation?
Inflation is a sustained rise in an economy’s general price level
How does Demand pull inflation occur?
Demand pull inflation occurs when aggregate demand shifts to the right
Explain the chain of reasoning on why we see demand pull inflation?
When aggregate demand shifts to the right their is greater pressure on the existing factors of production to produce more output as they are becoming scarcer. therefore when more pressure is put on a scare resource prices rise. e.g. wages will increase, price increase so costs of production increases and firms pass on costs to consumers so prices rise
What factors can lead to demand pull inflation?
reduction on interest rates
lower income/cooperation tax
boost in consumer/ business confidence
increase in government spending
weaker exchange rate
How does cost push inflation occur?
Cost push inflation occurs when SRAS shifts to the left.
Explain the chain of reasoning on why we see cost push inflation?
SRAS shifts to the left when their is an increase in cost of production for the majority of firms in the economy. firms pass on higher costs to consumers via higher prices of goods and services
what factors can lead to cost push inflation?
increase in the price of raw materials
increase in wages
increase in business tax
increase in price of imported raw materials due to weak exchange rate
What is the definition of deflation?
The persistent fall in prices in an economy in a year.
what are the two types of deflation and which one is good or bad?
Demand side (bad) supply side(good)
when does demand side deflation occur?
when aggregate demand shifts to the left
when does supply side deflation occur?
when short run aggregate supply shifts to the right
Why is demand side deflation bad?
demand side deflation is bad as it comes with lower growth
deflation is assumed to be long term and anticipated e.g. recession last for a time.
why is supply side deflation good?
supply side deflation is good as it comes with higher growth
more likely be short term and unanticipated e.g. material prices may be low today causes deflation but is very volatile
Why is anticipated deflation dangerous?
Delayed spending (reduces AD so lower growth high unemployment)
positive real interest rates (incentivises saving)
increase in value of debt (profits and incomes fall harder to service debt as it stays the same)
Why is short term inflation good?
lower price for consumers improves living standards
falling prices means businesses can buy inputs (e.g. capital/ stock reducing costs of production)
what are the costs of Inflation?
loss of purchasing power (effects living standards)
erodes savings as interest rates aren’t following effects lots of the economy e.g. pensioners who live off savings
lower export competitiveness (worsening current account)
risk of anticipated inflation e.g. workers asking for higher wages further increasing inflation and rational consumers buy more
fiscal drag (inflation rises and workers pay rises the same but could push workers into higher band of progressive income taxes system)
inflationary noise (volatile inflation could lose value of price signalling function) so consumer put of consumption + firms put off investment
shoe leather costs e.g. consumers search for best prices = opportunity costs
menu costs firms have to adjust price lists often
what are the benefits of inflation?
workers can bargain for higher prices (good for moral)
consumption is more natural
firms encouraged to increase output profit (incentive)
unemployment low in recession
easer to service debt
improvement in government finances e.g. VAT revenue increase as price of products rises
what is the macro objective for inflation
low and stable inflation
