2.1 Inflation Flashcards
What is deflation?
A sustained decrease in the general price level of goods and services in an economy
What is retail price index (RPI)?
A measure of inflation that tracks the changes in price of a fixed basket of goods and includes housing costs e.g mortgage, council tax (alternative measure)
What is inflation?
A sustained rise in the overall average price level in an economy
What is demand-pull inflation?
Inflation caused by a rise in aggregate demand
People are spending more and firms may not be able to increase production quick enough
What is core inflation?
A measure of the inflation rate that excludes temporary volatile factors e.g energy/food prices
What is cost-push inflation?
Inflation caused by rising costs
Higher costs means that its harder for firms to produce so higher prices passed on to consumers
What is disinflation?
When the rate of inflation falls but is still positive (prices are still rising but at a slower rate)
Describe the debt deflationary spiral
- Deflation creates future price fall expectations + consumption is postponed
- Postponed consumption results in falling revenue and demand
- Falling prices increase real value of debt making it harder to repay
- Increased bankruptcies so banks reluctant to issue loans
Why is deflation not necessarily bad?
- May be caused by sustained falls in factor costs e.g oil prices (reduced production costs=increased profits)
- May be caused by long term productivity improvements e.g technological advances
What is a deflationary spiral?
When falling prices cause further deflationary pressures to cut prices
What is the formula for price index?
Price of basket in specific year/ Price of basket in base year x 100
What is consumer price index (CPI)?
A measure of inflation that focuses on the average change in prices that consumers pay for goods/services in an economy over time
What is CPIH?
An extension of CPI which measures the rate of inflation and includes the costs of owning and living in a home (owner occupier housing costs)
How do you calculate weighted price index?
Year A:
(price of good x weight) + (price of good x weight)
Year B:
(price of good x weight) + (price of good x weight)
Percentage change of Year A + B
What is NAIRU?
Non accelerating inflation rate of unemployment
The level of unemployment at which inflation is stable/constant in the economy
What does the long run phillips curve suggest?
There is no trade-off between unemployment and inflation. The two variables are unrelated
What does the phillips curve suggest?
There is a trade-off between the rate of unemployment and inflation. They have an inverse relationship
Explain the trade-off between unemployment and inflation
As economic growth increases, unemployment falls due to the creation of new jobs. This causes wages to increase leading to more consumer spending and therefore increase in price level
3 limitations of using CPI when measuring inflation
- The basket of goods is only representative of the average household, so it is not accurate for typical households
- CPI is slow to respond to new goods/services (even though it is updated regularly)
- Different demographics have different spending patterns
Draw:
Long-run Phillips curve + Short-run phillips curve
Describe the steps for constructing CPI/measuring inflation
- Family expenditure survey (what consumers are spending income on)
- Prices survey
- Weightings (according to how much income is spent on each item)
- Choose a base year for index
- Compare change in index level to calculate % change
How does a government attempt to lower unemployment affect the SR phillips curve?
+ DIagram
- Inflation is increased to reduce unemployment (through expansionary policies)
- However, SR phillips curve shifts inwards towards NAIRU/LR phillips curve
- Inflation means workers demand higher wages=production costs
- FIrms fire workers causing unemployment to shift to its original position + inflation remaining high
