2.1.2- Inflation

Question 1

What is inflation?

Answer 1

The sustained rise in the general price level over time

Question 2

What is the UK target per annum for inflation?

Answer 2

2%

Question 3

What is deflation?

Answer 3

The sustained fall in the general price level over time

Question 4

What is disinflation?

Answer 4

Falling rate of inflation

Question 5

What is hyperinflation?

Answer 5

Really high inflation, over 50% per annum

Question 6

What is reflation?

Answer 6

Deliberate attempt to increase the general level of prices

Question 7

What is stagflation?

Answer 7

High inflation and stagnant economic growth

Question 8

How do we calculate the inflation rate?

Answer 8

By using the consumer price index

Question 9

What is the consumer price index?

Answer 9

A weighted basket of goods that measures average price change of the goods and is update annually using a survey

Question 10

How many goods are measured in the CPI?

Answer 10

710 products in 141 locations

Question 11

What are the steps to measure the inflation rate?

Answer 11

1. Obtain some price information
2. Group products into categories
3. Weight price changes into categories
4. Turn weighted categories into an index

Question 12

Why do we use index numbers?

Answer 12

• easier to compare values over time and trends
• simplifies complex numbers
• helps with international comparisons as all the values are the same units
• equates numbers of different magnitudes

Question 13

What are the limitations of CPI?

Answer 13

-only representative of the average household
-fails to take into account improvements in quality
-cpi is slow to catch up
-doesn’t include the price of housing

Question 14

What does RPI include that CPI doesn’t?

Answer 14

Housing costs such as mortgage and interest payments, and council tax

Question 15

Who does RPI exclude?

Answer 15

The top 4% of income earners and low income pensioners

Question 16

What are the causes of inflation?

Answer 16

-demand pull
-cost push
-growth of the money supply

Question 17

How does demand pull inflation work?

Answer 17

Stimulus to AD, consumers go out and spend extra money, firms can’t keep up with extra demand, consumers bid up prices

Question 18

What triggers demand pull inflation?

Answer 18

-depreciation in the exchange rate
-fiscal stimulus in the form of lower taxes or higher gov spending
-lower interest rates
-high growth in uk export markets

Question 19

How does cost push inflation work?

Answer 19

Raw material prices increase due to external shocks or demand rise, so prices rise

Question 20

What triggers cost push inflation?

Answer 20

-raw materials becoming more expensive
-labour becomes more expensive
-expectations of inflation, so may ask for higher wages
-indirect taxes
-depreciation in the exchange rate so imports of raw materials are more expensive
-monopolies can exploit consumers

Question 21

How does growth of the money supply work?

Answer 21

More money is produced to spend but no increase in AS, so prices increase

Question 22

What can growth of the money supply cause?

Answer 22

Hyperinflation

Question 23

What is the wage price spiral?

Answer 23

Employees real wages fall, so they ask for higher wages, therefore businesses costs rise, so prices increase, leading to real wages to fall again

Question 24

How does inflation affect those in low and fixed incomes?

Answer 24

They are hit hardest due to its regressive effect as the cost of necessities rise

Question 25

How does inflation affect those who have loans?

Answer 25

The value of repayment will be lower so the real value of the debt decreases

Question 26

How does inflation affect consumers’ confidence?

Answer 26

They will be more pessimistic about the future, so will increase savings, therefore consumption will decrease

Question 27

How does inflation affect interest rates ?

Answer 27

Interest rates will rise so the cost of investing will be higher

Question 28

How does inflation affect firm competitiveness?

Answer 28

On a global scale, firms will be less competitive due to price increases

Question 29

How does inflation affect animal spirits?

Answer 29

Decrease in animal spirits so decreased investment

Question 30

What are menu costs?

Answer 30

Having to reprint prices to keep prices up to date with inflation

Question 31

How does inflation affect the government?

Answer 31

They will have to increase the value of the state pension and welfare payments as the cost of living is increasing

Question 32

What may happen to workers as a result of inflation?

Answer 32

If firms face higher costs, there could be more redundancies

Question 33

Why is deflation bad?

Answer 33

It encourages people to postpone their purchases as they wait for the price to fall further