2.1.2, Inflation

Question 1

What is inflation?

Answer 1

Inflation is a sustained fall in the general price level

Question 2

What is deflation?

Answer 2

A sustained fall in the general price level. Often a sign of stagnation in an economy

Question 3

What is disinflation?

Answer 3

A fall in the rate at which the general price is rising

Question 4

Explain how rate of inflation is measured by consumer price index (CPI)?

Answer 4

• Living costs and food survey collects from nearly 7000 households every month
  -700 most common used goods are put into “consumer basket of goods”
  -Weights assigned to each item. Weights reflect proportion of income spent on each item in average basket.
  -Price changes are multiplied by the weights to give price index
  -Rate of inflation can then be measured by calculating the percentage change in this index over consecutive years.

!! CPI doesn’t including housing costs such as rent payments and mortgage interest repayments

Question 5

What are limitations of using CPI to measure inflation?

Answer 5

• Doesn’t include housing costs
• Some people don’t have representative spending patterns and may experience cossy lives by more or less
• Attempts made to consider changes of quality or weight of goods but adjustments may be imprecise
• List of 700 items is changed every year so sudden changes in spending is not considered
  -Sampling issues. Households may not provide precise info

Question 6

What’s the difference between CPI and RPI?

Answer 6

RPI does include interest payments on mortgages but is not as reliable as CPI for international comparisons.

Question 7

How can demand pull inflation be caused?

Answer 7

Demand pull inflation comes about from more spending within the economy (consumer demand)

Question 8

How do you calculate aggregate demand?

Answer 8

C+G+I+(x-m)
C - Consumer spending
G - Government spending
I - Investments
x - Exports
m - Imports

Question 9

How can cost push inflation be caused?

Answer 9

Cost push inflation comes from higher costs of production across the economy.

Question 10

What increases cost push inflation?

Answer 10

• Higher wages
• Higher material costs
• Lower productivity
• Higher business rates

Question 11

How can growth of the money supply lead to inflation?

Answer 11

• Associations with an increase in aggregate demand in the economy
  -> increasing money supply, ceteris paribus, leads to more money in economy chasing same no. of goods/services
  -> If money supply grows faster than the output of the economy its likely to cause inflation

Question 12

What is the impact of inflation on consumers?

Answer 12

• Each pound is worth less - less spending power
• Could be regressive if higher inflation is driven by rising prices of necessities like fuel, food, housing etc.

Question 13

What is the impact of inflation on workers?

Answer 13

• Could lead to fall in income in real terms
• Employees in poor bargaining positions tend to lose out

Question 14

What is the impact of inflation on savers?

Answer 14

Reduces the real value of savings

Question 15

What is the impact of inflation on borrowers?

Answer 15

Reduces real value of debt

Question 16

What is the impact of inflation on firms?

Answer 16

• Increased ‘menu costs’ due to rapid changing prices
• Loss of competitiveness compared to foreign firms
• Rising costs in materials and labour
• Less investment due to lower confidence
• Higher prices -> greater revenues

Question 17

What is the impact of inflation on the government?

Answer 17

• Value of real debts falls
• Having to deal with high inflation makes it hard for them to achieve other objectives

Question 18

What is the impact of inflation on economy?

Answer 18

• Objective of low inflation not met
• Lower investment = lower real output
• Loss of competitiveness worsens current account
• Lower investment = increasing unemployment