2.1.2: Inflation

Question 1

What is inflation?

Answer 1

The general increase of prices in the economy
OR
the fall in the purchasing power of money.

Question 2

What is deflation?

Answer 2

The fall of prices that indicates a slowdown in the rate of growth/output in the economy.
-e.g. price of ice cream reduces from £2 to £1.

Question 3

What is disinflation?

Answer 3

A reduction in the rate of inflation (i.e. prices are still rising but not as much as before).
-e.g. inflation rate falls from 2.5% to 2%.

Question 4

How is data collected for the Consumer Price Index (CPI)?

Answer 4

The Office for National Statistics (ONS) collects prices on:
-700 goods/services.
-20,000 shops.
-141 locations.
in a typical basket of goods and services, which is designed to represent typical purchases of UK consumers.

A base year is selected, and a survey is carried out on 40,000 households.

Question 5

In the CPI, different items are weighed on ________ and ________ %.

Answer 5

Importance, expenditure.

Question 6

What is an example of how different products are weighed?

Answer 6

Petrol, high % expenditure, few substitutes.
Postage Stamps, low % expenditure, many substitutes.

Question 7

What are limitations of CPI?

Answer 7

-Not fully representative- will be inaccurate for the ‘non-typical’ household (e.g. petrol, non-car owners).
-Omits housing costs- a significant part of people’s spending.
-New products- the CPI is slow to respond to new products (the basket changes by a few products annually).

Question 8

How is the Retail Price Index (RPI) different to CPI?

Answer 8

-RPI takes housing costs into account.
-RPI excludes ‘non-average’ households (e.g. top 4% income earners). 
-RPI is generally higher than CPI, as it doesn’t take into account that when prices rise, people switch to cheap products.

Question 9

What are the three causes of inflation?

Answer 9

-Demand pull.
-Cost push inflation.
-Growth of money supply.

Question 10

What is demand pull?

Answer 10

Excessive growth in AD (compared to AS).

Question 11

What is aggregate demand?

Answer 11

Total demand for goods & services in the economy.

Question 12

What causes demand pull?

Answer 12

-High consumer spending (confidence about the future).
-Economic growth.

Question 13

What is cost push inflation?

Answer 13

A rise in costs caused by a decrease in AS.

Question 14

What causes cost push inflation?

Answer 14

-A rise in wages (above increase in productivity).
-Rising costs of raw materials (may be as a result of devaluation of currency).

Question 15

What is growth in money supply?

Answer 15

Too much money in the economy, causing an excessive increase of demand (causing prices to rise).

Question 16

What is anticipated inflation?

Answer 16

Expected inflation, where steps have been taken to mitigate its effects (e.g. indexation).

Question 17

What is indexation?

Answer 17

Wages and taxes being adjusted in line with inflation.

Question 18

What is unanticipated inflation?

Answer 18

Inflation that is not estimated by the government, so no steps have been taken to adjust the economy.

Question 19

How does inflation affect consumers?

Answer 19

-Fall in living standards due to less disposable income.
-Borrowers benefit from a reduction in the value of debt in real terms.
-Savers suffer a fall in the value of savings in real terms.

Question 20

How does inflation affect firms?

Answer 20

-They will become less competitive as goods are more expensive, making them more difficult to export.
-Inflation is difficult to predict, so firms can’t plan for the future.
-Firms have to calculate new prices, then change menus and/or labelling.

Question 21

How does inflation affect government?

Answer 21

-Real government revenue will fall if they don’t adjust excise taxes.

Question 22

How does inflation affect workers?

Answer 22

-Lack of job security.
-If workers don’t receive pay rises in line with (or above) the inflation rate, they will have less disposable income.

Question 23

What is an example of cost push inflation?

Answer 23

1970s: OPEC took steps to decrease global oil supply. There was no significant increase in the volume of consumption, but prices surged.

Question 24

Why is deflation bad for the economy?

Answer 24

Deflation indicates low or suppressed AD.
1. As prices are falling, consumers tend to delay consumption (because they think prices will fall further in the future).
2. Consumption slows significantly.
3. Firms will lose the confidence to invest, harming AD further.

Question 25

What are excise taxes?

Answer 25

Taxes at a set amount (e.g. £10).

Question 26

What is core inflation?

Answer 26

Inflation that excludes products from the food & energy sectors.