2.1.2 Inflation

Question 1

Inflation

Answer 1

The increase in the general level of prices in the economy.
-Fall in the purchasing power of money. e.g. inflation rises from 2%-3%

Question 2

Deflation

Answer 2

The decrease in the general level of prices in the economy.
-Rise in the purchasing power of money. e.g. inflation falls from 0%- -1%

Question 3

Disinflation

Answer 3

The decrease in the rate of inflation.
-General level of prices are still rising but at a slower rate. e.g. inflation falls from 5%-4%

Question 4

Process of calculating Consumer Price Index (CPI)

Answer 4

1. A household expenditure survey is completed.
2. The most popular goods/services will be put into a basket of goods/services.
3. This is used to attach weights to goods/services, according to the proportion of spending.

Question 5

1. Limitations of CPI: Basket may not represent all consumers spending habits.

Answer 5

Although thousands of households are used in the family expenditure survey, it does not mean the overall basket of goods represents spending habits of all households. This leads to the data being inaccurate for households whose shopping habits do not contain the majority of goods/services that are in the basket of goods/services.

Question 6

2. Limitations of CPI:

Answer 6

Different measurements of inflation are used by different countries. This makes it difficult to make comparisons between countries that use RPI for example.

Question 7

3. Limitations of CPI: Does not include the costs of housing.

Answer 7

Housing costs has tended to rise more than the price of other goods, this may lead to the data being lower than it should be.

Question 8

Retail Price Index (RPI)

Answer 8

-RPI takes into account housing costs such a mortgage, interest rates, and council tax, whereas CPI does not.
-RPI is generally higher than CPI. As housing costs increase at a relatively high rate.

Question 9

Causes of inflation: Demand Pull

Answer 9

This occurs when there is an increase in aggregate demand
-The increase in demand for more goods and services, puts more pressure on existing factors of production, forcing firms to put up their prices.

Question 10

Causes of inflation: Cost Push

Answer 10

This occurs when there is a decrease in aggregate supply.
-Costs for businesses have risen, resulting in them putting up their prices to maintain profit margins.

Question 11

Causes of inflation: Growth in Money Supply

Answer 11

This occurs when the central bank lowers the base interest rate (or quantitative easing)
-This increases the amount of borrowing by firms and consumers, driving consumption and investment. Leading to demand-pull inflation.

Question 12

Effects of inflation: Consumers

Answer 12

Positive:
Consumers will benefit as the real value of debt/loan repayments (i.e. mortgage) fall. Easier to pay off.
Negative:
Reduction in purchasing power and real wages. Consumers will have less to spend, which could cause a fall in living standards

Question 13

Effects of inflation: Firms

Answer 13

Positive:
Real value of debt/loan repayments fall. Easier to pay off.
Negatives:
British goods become less competitive. If inflation is higher in Britain than other countries, British goods will be more expensive, making it more difficult to export. Reducing profits.

Question 14

Effects of inflation: Government

Answer 14

Positives:
May makes the national debt smaller in real terms, making it cheaper to finance and pay back.
Negatives:
British goods become less competitive. If inflation is higher in Britain than other countries, British goods will be more expensive, making it more difficult to export. Worsening the balance of payments.