1.2.1 Inflation Flashcards
What is inflation?
- A sustained rise in price level
- Fall in real purchasing power of money, rise in cost of living as each pound can buy less and money loses it values
- UK set base rate of 2% using the CPI
What is deflation/disinflation
- Deflation fall in general price level e.g. negative inflation
- Disinflation is slowdown in rate of increase of prices
What is hyperinflation and stagflation?
-Hyper is extremely high, usually reserved for historical events
Stagflation - rising prices at same time as unemployment
What is the CPI?
Consumer price index is a way of measuring inflation in the UK
- Base year is selected and family expenditure survey is carried out
- 740 goods from 140,000 sellers are chosen in each country and are weighted based on the importance of expenditure e.g. fuel is weighted higher
-Weights are then multiplied by the price changes which then calculates the inflation rate
In a question, add up all the index x weighting then divide by the sum of the weights, giving the price index e.g. 102 is inflation of 2%
What are the disadvantages of CPI?
- Doesn’t account for typical household costs - CPIH better for this
- i.e. non car owners spending different
- Spending patterns are different
- Changing good sand services - can’t control quality
- New products - slow to respond
- Inequalities
What is RPI and what are the differences between RPI and CPI
Retail price index, include mortgage interest
Similar:
- Based on weight and cost of basket
- CPI wider sample
- RPI exceeds top 4% households
- RPI includes housing costs - mortgage interest
- CPI internationally agreed
- Geometric CPI reflects changing spending patterns
- CPIH/RPI better due to housing costs significant.
What are the general causes of inflation?
- Wage price spiral - wages/increase costs lead to inflation in spiral higher costs -> higher prices -> higher wages -> higher costs
- Exchange rate rise - SPICED
- Inflationary pressures from outside country
Expectations - calculations and expectations can lead to higher wages and costs artificially
What is demand pull inflation?
-Total demand exceeds total supply and forces prices up, shifting approaching full employment and causing labour and material shortages making it harder for firms to expand production. When demand rises it also incentivises producers to raise prices to increase profits. Arguably natural due to built in inflation from the wage price spiral
Caused by:
- Rise in real incomes
- Rise in GDP
- Credit
- Reduce tax
- Reduce interest payments/rates
- Easy credit
- Wealth effect and confidence
- Consumer knowledge and advertisements
- Increased investment by firms due to low interest and credit rates + confidence
- Government spending rises to pay for demand in services
- Discretionary spending - changing tax, monitoring, capital projects
- Rise in demand for UK exports, fall in demand for exports
What is cost pull inflation?
-Cost of production increases - may be wage prices, rent, materials or indirect taxes. Causes SRAS to shift left leading to fall in revenues and investment spending, leading to stagflation as employment may fall with inflation
Causes:
- Wages rise - scarcity of human capital/skill
- Tax rise - e.g. national insurance
- Price inflation - wage/price
- NMW
- Rise in capital price
- Rise in rent
- Rise in raw components and materials
- Rise in oil price
- Weak £, rising cost of imported raw materials
- Full capacity reached
What is monetary inflation? What is the process?
Growth of the money supply increased faster than economies growth rate, causing inflation. As the output rises, each unit is worth less.
- Money supply rises -> shift in AD
- Firms expand LRAS output
- Output exceeds equilibrium so inflationary gap as AD is shifted outwards
- Firms hire more and wages rise, costs rise, prices rise
- As prices rise money buys less, contraction along new AD curve
- Supply then contracts to meet the contraction in AD as workers want more wages
- Returns to equilibrium however at much higher price level
- Increase in money leads to rise in AD but as LRAS is inelastic prices just rise
What is the fisher equation?
MV = PT = Total spending in the economy
M = money supply V = velocity of money - how many times it changes hands
P = average price level T = volume of output
If there is an increase in money then price will rise
How do keneysians/monetarists views on inflation differ?
Monetarists believe price levels are related to amount of money in the economy
Keynesians believe velocity and circulation change - when more people save velocity falls and if you raise money supply instead of average price level you can raise output
Who are the winners and losers of inflation?
Winners:
- Workers with wage bargaining power
- Debtors if interest rates fall - loans become negative
- Producers if prices rise faster than costs
- Wealthy groups if assets rise
Losers:
- Retired on fixed incomes
- Lenders if real interest rates negatives
- SAvers if returns lost
- Workers in low paid jobs
- Exporting firms lose sales and profits
What are the costs of inflation?
- Shoe leather - time taken to find best prices and interest
- Menu - cost of changing prices
- Psychological/political
- Loss of international competitiveness, (withdrawal + deficit)
- Uncertainty
- Fall in investment from abroad as value of money lost
- Cut back on spending to save
- Incomes shifted from savers to borrowers
- Low incomes lose out
- Only workers who can negotiate maintain living standard
- Inequality
- Falling real incomes
What are the benefits of inflation?
- Reduces real interest rates - cost of borrowing falls, those with large debts see debt fall - those on interest or have lots in savings see values fall
- Profit incentivises investment
- Prevents deflation
- Wages and benefits cut in real terms by giving below inflation wage rises, reducing real costs
