2.1.2 - Inflation Flashcards
What is inflation
- A sustained increase in the general price level
- leads to a fall in the real purchasing power of money
How is the rate of inflation measured
Annual percentage change in consumer prices
What is deflation
A fall in the general price level ‘negative inflation’
What is disinflation
- A slowdown in the rate of increases in prices
- Prices are still rising but at a slower rate
What is the consumer price index (CPI)
A measure of the price level based on the prices of a collection of products designed to reflect the consumption basket of the average consumer
How does the CPI work
- A base year for prices is selected and a family expenditure survey is carried out, the survey tracks what people are buying
- A representative basket of over 600 goods and services used, weights attached to each item based on items importance in people’s expenditure
- Weights are multiplied by price changes
- Weighted price changes are totalled to calculate inflation rate
How do you calculate CPI
Sum of price indices x weights / sum of weights
Limitations of CPI as a measure of inflation
- CPI is not fully representative, inaccurate for the ‘non-typical’ household
- Spending patterns
- Changing quality of goods and services, although price could rise, may be accompanied by improvements in quality/performance
- Doesn’t account for regional differences in cost of living
What is hyper-inflation
- A period of high rates in inflation, usually leading to a loss of confidence in an economy’s currency
Name some domestic causes of inflation
- Rising wage costs
- Increases in the costs of component parts of raw materials
List some external causes of inflation
- Increase in the global price/cost of energy and other inputs
- Movements in the exchange rate of a country’s currency, e.g. currency weakens, imported goods will become more expensive pushing up domestic production costs
What is the importance of inflation expectations
- Agents (e.g. workers, businesses and lenders) will raise their inflation expectations and build it into their calculations and decision
- Rise in inflation can lead to an increase in inflation expectations, can feed through to higher wage claims and rising costs
When does cost push inflation occur
- When the costs of production for businesses increase
- E.g. increases in wage costs, cost of raw materials, rents or indirect taxes such as VAT
What happens during cost-push inflation
- Output of goods/services and employment both fall due to a rise in costs leading to a fall in business profits and planned investment spending
- Cost-push inflation can bring about stagflation, slow growth and inflation
When does demand pull inflation occur
- When total demand for goods/services exceeds total supply
- As economy approaches full employment, labour and raw material shortages occur more frequently making it more difficult for firms to expand production to meet rising demand
