2.1.2 inflation Flashcards
Define the term “inflation”
A sustained increase in the average price level over a period of time
OR
A decrease in the value of money over a period of time
Why is inflation an important economic measure?
- used by BoE to decide interest rates (monetary policy)
- Used by goverments to decide pensions,benefits etc
- used by businesses to decide wages and prices
- affects exchange rate between currencies.
How do you calculate inflation?
1) firstly the goverment choose a basket of goods/servies from a consumer survey (roughly 700 items)
2) each item is given a weighting based on how much consumers spend on them each year (total weight = 1000)
3) Researchers record the prices of each good in the middle of every month (eg brand price disparity, also account for improvements in the quality/reduction of quantatity)
4) The office of national statistics (ONS) collates the prices and calculate an avg for each item.
5) The ONS calcualtes a weighted average from all the averages and converts the figure into an index.
not ALL prices increase - just an average increase
limitations of CPI in measuring the rate of inflation?
- Differences in quality/size may not be accurate (step 3)
- The actual effect of price changes effect different people in diff ways (ie tobacco tax affects a smoker more than a non smoker…)
- CPI doesnt account for changes in housing costs.
What is demand pull inflation?
Too much demand in the economy and insufficient capacity to meet the demand.
Reasons for demand pull inflation?
- decrease in income tax = increase in disposable income
- decrease in interest rates = decreased cost of borrowing and less returns from savings (people spend rather than save)
- injection into the economy from goverment spending
What is cost push inflation?
Occurs due to higher costs in the economy. High costs affect businesses who pass it onto consumers (increased prices).
Reasons for cost push inflation?
1) trade unions achieving higher wages for employers
2) higher costs of essential imported raw materials
3) increases in other business costs like energy prices.
What is money supply inflation?
More money in the money supply = higher level of prices
Explain the money supply equation (fisher equation)
M x V = P x Y
M= total money in supply
V= number of times money circulates
MxV = total expenditure in the economy
P = average level of prices
Y = output of goods ands services
PxY = value of all the goods sold in the economy.
V and Y are constant.
TOTAL EXPENDITURE IN ECONOMY = VALUE OF GOODS SOLD IN ECONOMY
What does the money supply inflation idea assume?
- Assumes economy is at full employment (Y is constant and its max)
- assumes velocity of circulation is contant
- ignores savings
- other causes of inflation (CP + DP)
Why is having a positive inflation rate of 2% important?
- Sign of economic growth
- Means that prices are rising
- Means that profits are rising = higher wages = more investment (in small amount)
- UK should sell more exports (goods should be cheaper than other countries)
- low risk of wage price spiral (HIGH inflation can result in this)
Govt target = 2% (-/+ 1%)
Drawbacks on having a inflation rate of 2%?
- Loans are harder to repay beacuse household incomes and firms profits dont rise very much.
- Incomes and profits only rise a small amount. - worse QOL?
economic impacts of HIGH inflation on consumers?
where inflation is > 10%
Positives
* * Household debt easier to pay off (as value of money is reduced compared to when you borrowed)
Negatives
* Reduction in purchasing power and real incomes of UK consumers as price level increases so consumption would decrease - incomes dont rise in line with inflation - worse living standards - drive low income people into poverty.
economic impacts of HIGH inflation on workers?
Positives
* Commision workers recieve higher income due to effect of commision.
Negatives
* Unemployment in the UK may rise as firms costs increase.
Firms have to pay new higher ,min wage, sack off workers , or
