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
