2.1.2 Causes of Inflation Flashcards
what are the three causes of inflation
- demand-pull
- cost-push
- growth of the money supply
define demand pull inflation
a sustained rise in the general price level caused by excessive total demand in an economy for goods and services
why does demand pull inflation occur
- there is too much money chasing too few goods and services
- when there is excess demand, producers will increase their prices to maximise profit margins
which stage in the economic cycle is demand pull inflation usually associated with
boom
how does reduced income tax and corporation tax cause demand pull inflation
cut in direct taxes, consumers have more disposable income so consumption increases.
firms have increased retained profit so investment increases
increase in consumption and investment increases AD
how do lower interest rates cause demand pull inflation
lower cost of borrowing and reward for saving, so consumption and investment increase, increasing AD
how does increased consumer spending cause demand pull inflation
maybe due to increased confidence or incomes
increase in consumption increases AD
how does improved availability/affordability of credit cause demand pull inflation
borrowing is easier and cheaper, increase in consumption and investment increases AD
how does a weak exchange rate cause demand pull inflation
weaker pound, imports more expensive as £1 can buy fewer units of foreign currency, exports cheaper as £1 cheaper for foreign consumers, increased net exports, increased AD
how does fast growth in other countries cause demand pull inflation
increased GDP abroad, increased average incomes, increased demand for exports, increased net exports increases AD
how does increased confidence and certainty cause demand pull inflation
increased consumption and investment, increase in AD
how is demand pull inflation shown on a diagram
outward shift in AD
define cost push inflation
a sustained rise in the general price level, caused by firms responding to rising costs of production by increasing prices of output
why does cost push inflation occur
- firms increase prices to protect profit margins
- firms pass on high costs to consumers in the form of higher prices
- this will often cause a reduction in AS in the economy
how do wage increases cause cost push inflation
increased cost of production, decrease in SRAS resulting in a higher GPL
explain the wage price spiral
when GPL rises, real incomes fall, workers demand higher wages, wage costs for firms rise, increasing prices
how do higher raw material costs cause cost push inflation
increase in cost of production (especially if resources are scarce in supply), decrease in SRAS resulting in higher GPL
how do higher taxes cause cost push inflation
increase in indirect taxes e.g VAT on raw materials, leads to an increase in the cost of production, higher GPL as lower SRAS
how do higher import prices cause cost push inflation
weaker pound, imports are more expensive as £1 buys fewer units of foreign currency, importers of raw materials and components have a higher cost of production, so higher GPL as lower ASRAS
how do natural disasters cause cost push inflation
temporary or permanent decrease in supply of raw materials/components causes an increase in the cost of production, so higher GPL as lower SRAS
how is cost push inflation shown on a diagram
shift SRAS inwards
define shrinkflation
the practice of companies reducing the size or quantity of a product, while keeping the price the same or even raising it
give some causes of the surge in UK inflation in 2022-23
- pandemic related supply shortages
- conflict in Ukraine
- labour shortages
what is the money supply
a measure of the amount of stock on=f money in the economy
what is narrow money (M0) and broad money (M4)
M0 - includes notes and coins in circulation
M4 - includes M0, bank deposits and other liquid assets
how can the central bank increase the money supply
- printing more notes through the B of E
- use quantitative easing to create money electronically
- reduce deposit holdings of banks allowing them to lend more money
- the B of E can buy bonds off financial institutions creating liquidity
how does a rising money supply cause inflation
greater supply of money, firms and consumers have more to spend, demand rises faster than supply creating excess demand, so firms increase prices to try and maximise profits
give a country that has experienced regular price deflation
Japan
what may cause deflation in an economy
demand side causes (inward shift of AD)
supply side causes (outward shift of SRAS)
what could be a demand side cause of deflation
-deep fall in AD causing a recessions
- large negative output gap, high level of spare capacity
what could be a supply side cause of deflation
- improved labour productivity
- technological advances
- significant fall in wage costs
- strong exchange rate causing import prices to fall
which cause of deflation is less damaging and why
supply side - leads to actual growth
which cause of inflation is considered less harmful and why
demand pull inflation is considered less harmful than cost push as it is associated with rising AD, actual growth and improved living standards
which cause of inflation is considered more harmful and why
cost push - tends to be associated with falling output (known as stagflation)
give another ev point for causes of inflation
businesses may choose to use increased profit margins to invest in new capital, increasing productive capacity in the future
