2.1.2 - Inflation Flashcards
What is Inflation (Price Level)
A sustained rise in the general price level
What is Inflation (Purchasing Power)
A fall in the purchasing power of money
How is inflation (changes in the price level) measured?
Using an Index such as the Consumer Prices Index (CPI)
What are the benefits of using an index to measure changes in the price level (inflation)?
% changes can be shown easily with an index, making effective comparisons possible.
What are Index Numbers?
- A statistical measure that allows easy comparison of changes in a variable compared to a base year.
Consider the Index Numbers for the P/L below:
Year Index Number
2010 100
2011 105.7
2012 113.7
What was Inflation from 2010 to 2011?
105.7 - 100
—————- X 100 = 5.7%
100
Consider the Index Numbers for the P/L below:
Year Index Number
2010 100
2011 105.7
2012 113.7
What was Inflation from 2011 to 2012?
113.7-105.7=8
Inflation = (8 / 105.7 x 100)
= 7.57%
(Change / Original) x 100
PROBLEMS OF INFLATION FOR CONSUMERS
What is the effect of inflation on the real value of savings?
The real value of savings falls as prices rise, discouraging people from saving.
Inflation reduces the purchasing power of saved money.
PROBLEMS OF INFLATION FOR CONSUMERS
How does inflation affect purchasing power?
Purchasing power falls if wages do not rise as fast as inflation, especially affecting those on fixed incomes.
Example: Pensioners relying on annuities.
BENEFITS OF INFLATION FOR CONSUMERS
What is a benefit of inflation for individuals with high personal debt?
Debt value reduction, as the real value of the debt falls with inflation.
This means they pay back less in real terms.
PROBLEMS OF INFLATION FOR FIRMS - INCREASED COSTS
What are Menu Costs in the context of inflation?
Administrative costs associated with regularly re-pricing products due to inflation.
These costs can affect a firm’s profitability if inflation goes up continuously.
PROBLEMS OF INFLATION FOR FIRMS - INCREASED COSTS
What is meant by shoe leather costs?
Costs incurred when firms spend more time searching for the lowest prices due to varying inflation rates.
This reflects the inefficiency caused by inflation.
PROBLEMS OF INFLATION FOR FIRMS - LOSS OF INTERNATIONAL COMPETITIVENESS
How does inflation impact a firm’s international competitiveness?
Exports become more expensive and imports cheaper if domestic inflation is higher than abroad, worsening the balance of payments.
This can lead to trade deficits.
PROBLEMS OF INFLATION FOR FIRMS - INCREASED UNCERTAINTY
What is the effect of inflation on business investment?
Increased uncertainty can lead firms to curb investment due to fears of rising costs and interest rates.
This is detrimental to long-term business growth.
PROBLEMS OF INFLATION FOR FIRMS - FOREIGN INVESTMENT DECREASE
How does inflation affect foreign investment?
Foreign investment may decrease as inflation erodes the value of money, making it less attractive to invest in that currency.
Investors seek stable currencies.
BENEFITS OF INFLATION FOR FIRMS - BIG-TICKET ITEMS
What is a potential consumer behavior change due to inflation regarding big-ticket items?
Consumers may bring forward their purchases of big-ticket items, anticipating higher prices in the future.
This can stimulate short-term economic activity.
What is a problem caused by inflation for those on fixed incomes?
Incomes fall in real terms.
How do index-linked incomes relate to inflation?
They will not lose out unless linked to an unrepresentative measure like the CPI.
What is a benefit of inflation for the government regarding debt?
Inflation reduces the real interest rate, thus lowering the cost of borrowing.
What is the approximate public debt of the UK government?
£1.5 trillion.
How does inflation affect the real value of debt?
The real value of debt falls when there is inflation.
What is a benefit of inflation related to deflation?
A little inflation provides a cushion against the perils of deflation.
What negative economic cycle can occur with deflation?
A vicious circle of underinvestment and reduced spending.
What effect does a little inflation have on economic confidence?
It can lead to confidence that the economy is buoyant with good levels of demand.
What problem might workers face due to inflation?
Lower employment opportunities.
Why might firms hesitate to pay higher wages during inflation?
Uncertainty about the future and fear of reduced demand.
What is deflation?
A fall in the general price level.
What happens to the purchasing power of money during deflation?
It increases.
