2.1.2 - Inflation

Question 1

Define Inflation

Answer 1

A general increase in the price level of goods and services in an economy, which decreases the purchasing power of money

Question 2

Define Deflation

Answer 2

A fall in the general price level in an economy

Rate of inflation will be below 0%

. Inflation will be negative

Question 3

Define Disinflation

Answer 3

. A fall in the rate of inflation. E.g. 5% to 2%

. Prices are still rising but at a slower rate

Question 4

Define Hyperinflation

Answer 4

. A period of very high rates of inflation, usually leading to loss of confidence in an economy’s currency

Question 5

Bank of England Target for Inflation

Answer 5

. Target is 2% (+/- 1%)

Question 6

Define Reflation

Answer 6

. A rise in GDP which occurs after a recession

Question 7

Define Stagflation

Answer 7

. A period where inflation is high or rising during a recession

Question 8

Define Deflationary Policies

Answer 8

. Policies used by the government to try reduce the rate of economic growth, so rate of inflation can also be decreased

. Can be monetary or fiscal

Question 9

Name two ways of measuring inflation

Answer 9

. Consumer Price Index (CPI)
. Retail Price Index (RPI)

Question 10

Key Thing to Remember

Answer 10

. A fall in inflation is not the same as fall in prices! That is disinflation

. Only when there is deflation, will there be a fall in prices

Question 11

Define Consumer Price Index (CPI)

Answer 11

. A measure of price level in an economy based on prices of a collection of a basket of goods designed to reflect the consumption basket of the average consumer

Question 12

Explain how the Consumer Price Index measures Inflation

Answer 12

1.) From a large collection of survey data a basket of goods and services are formed to reflect the consumer spending habits of an average family

2.) Goods and services weighted according to the based on the % of income (0-1). E.g. If 5% of income was spent on grapes, then weighted be 0.05

Refer to Sheet :

3.) Weighted prices added each year to give total weighted price of basket e.g. £3,000

4.) Base year selected with index value 100. This base year can be any year

5.) Weighted basket prices converted into index number and then % change calculations done to work out annual inflation rates

6.) Basket updated yearly

Question 13

Limitations of the CPI as a measure of inflation

Answer 13

1. ) New Products — CPI is slow to respond to new products and services. The CPI basket is only changed each year but only a year items are removed and few items come in
2. ) Changing quality of goods and services — Although the price of good or service may rise, this may be due the quality of the good increasing, not necessarily inflation
3. ) CPI is not fully representative — it will be inaccurate for non typical households, e.g. 14% of the CPI index is devoted to motoring cost - inapplicable for non - car owners
4. ) CPI does not include housing cost such are rent, mortgages, council tax or maintenance. This is an issue with CPI as housing costs are too expensive

Question 14

Explain Retail Price Index (RPI)

Answer 14

. The RPI has very similar steps to calculating CPI

. HOWEVER, housing costs are in the RPI basket

. Also RPI is calculated using a different mean, which is an arithmetic mean. This means that RPI value will be higher than CPI

Question 15

Define Hyperinflation

Answer 15

When inflation levels become very high