2 - Inflation Flashcards
What is inflation?
Inflation is the sustained increase in the overall price level in an economy over time
What is inflation a measure of?
It is a measure of the cost of living
How can inflation rate be calculated?
(Change in CPI / previous year cpi) x 100
Basically just oercentage change in CPI
What is the UK’s target inflation rate?
2%
What is disinflation?
Disinflation is a fall in the rate of inflation
Just a drop e.g. 6% to 3%
What is deflation?
A negative inflation rate
E.g, -3%
What is hyperinflation?
Hyperinflation is very high inflation
What does hyperinflation do?
-Erodes wealth
-Erodes real value of the local currency
What does hyperinflation therefore lead consumers to do?
It leads to consumers having to spend their money as quickly as possible
What are the 2 measures of the price level in the UK?
Relative price index (RPI)
Consumer price index (CPI)
What is CPI?
-It is the main measure of inflation used in UK and EU.
-It is the price of a weighted average basket of consumer goods and services purchased by households
-Changes in CPI track changes in price over time
What are some limitations of CPI?
- The CPI is not fully representative
- Peoples spending patterns are different
- New products aren’t included in the CPI
- It doesn’t account for the regional differences in the cost of living
- Changing quality of goods and services
What is the basket of goods and services?
A fixed set of consumer products and services whose price is evaluated on a regular basis, often monthly or annually
What is CPI used to track
It is used to track inflation in the economy
What are the differences between RPI and CPI?
-The CPI doesn’t include council tax, mortgage interest repayments and some other housing costs
-RPI excludes the top and bottom 4% of earners in the economy
Why can CPI and RPI never be 100% accurate
- Basket not representative of every household
- Sampling errors due to population being so large
- Shrinkflation : changing the size of the products rather than the price
- Doesn’t take into account the increasing quality of goods and services
What is the redistribution effect and when does it arise?
When inflation redistributes income away from certain grownups in the economy to other groups. It arises when certain groups lose some purchasing power and become worse off and vice versa
How do people who receive fixed incomes lose from inflation?
As the general price level rises and their incomes don’t follow, they become worse off
E.g. Pensioners, Landlords, individuals with fixed welfare payments
How do holders of cash lose out from inflation?
As the price level increases, the real value or purchasing power of any cash held falls
How do savers lose out from inflation?
In general, savers who receive a rate of interest on their savings lower than the rate of inflation, suffer a fall in the purchasing power of their savings
How do lenders lose out from inflation?
Lending at a lower interest rate than the rate of inflation makes the lender worse at the end of the loan period
How do borrowers gain from inflation?
Borrowing at a lower interest rate than the rate of inflation makes the borrower better off at the end of the loan period
How do payers of fixed incomes gain from inflation?
The payers benefit as the real value of their payments to their workers falls due to inflation
What are menu costs?
Incurred by firms when they have to print new menus due to changes in price
How are menu costs affected by inflation?
The higher the rate of inflation or the more volatile it is, the more often firms have to change their price which makes menu costs higher
What is the money illusion?
It refers to the idea that some people feel better off when their nominal income increases, even though the price level may increase at the same rate and possibly even faster
What does the money illusion lead to?
It leads to consumers making incorrect decisions : they think they have more money than they really do and end up spending a lot more
How does an increase in inflation affect international competitiveness? And what does it lead to?
International competition is reduced. This results in the quantity of exports to fall and the quantity of imports to increase. This could create difficulties for the country’s balance of payments
What can inflation result from?
Demand side factors (demand pull inflation)
Supply side factors (cost push inflation)
What is demand pull inflation caused by?
Caused by an increase in aggregate demand (when the economy is in a boom phase)
Caused by excess demand
Why might demand pull inflation be caused?
-Consumer spending may rise excessively
-Consumer confidence could rise due to house prices rising
-Firms may substantially increase spending on investment
-World demand for UK exports may be rising because of a boom in the world economy, therefore increase in AD
What is the diagram for demand pull inflation the same as?
Increase in aggregate demand
What can cause cost push inflation?
Anything that causes aggregate supply to increase
Why does cost push inflation occur?
It occurs because of rising costs and it could occur because of changes in the supply side of the economy
What are the 4 major sources of increased costs?
- Increases in wages
- Increase in the costs if imports
- Profits can be increased by firms when they raise price to improve profit margins
- Governments can raise indirect tax rates or reduce subsidies, thus increasing prices
- firms will try pass on their increases in costs to customers
What might stop firms from passing on increases in their costs to the customers?
Competition
What is Cost pull inflation the same as?
Decrease in short run aggregate supply
What happens when you print more money
The more money you print, the higher the rate of inflation gets
What does a fall in real GDP cause?
When real GDP falls for an extended period of time, the economy enters a depression
