2.1.2- Inflation Flashcards
What is inflation
a rise in the general level of price of g/s in an economy over a period of time
What is deflation
a period when the general price level falls
What is disinflation
a fall in the rate of inflation
What is CPI
Consumer price index is a measurement of inflation used by the gov
What is RPI
Retail price index a measure of inflation quoted in the media but not used currently
What is CPIH
a new measure of inflation that i
claude’s the costs of owning and maintaining a home, an ajusted CPI takes into account changes in rents
What are the differences between CPI and RPI
-RPI contains mortgage payments CPI doesn’t
- CPI includes some financial services not included in RPI
-CPI is based on wider sample of population
What is the problem with RPI
a rise in interest rate would decrease inflation but also increase the cost for borrowing include mortgages which would show a rise in inflation in the RPI (rates have opposite effects)
How is inflation measured
-Basket of goods, represents what typical households spend income on, sample prices are collected every month for these 700 goods in 150 areas, to see price changes
How is the basket of goods updated
It’s reviewed each year, items are taken out and items are put in to keep up with consumer spending patterns
How are goods weighed
Weights are applied to items reflecting their importance in the typical household budget (proportion of spending), so CPI only reflects price changes not preference changes
What is an index number
A way of expressing economic data for comparing, an index number is compared to the base number of 100
How to calculate an index number
-choose base year
-divide by itself
-x100
-divide another figure by the base year
-x100
What is demand pull inflation
When excess demand in the economy creates an inflationary gap associated with a boom, ‘too much money chasing too few goods’, firms increase price to widen profit margin, when AD on YFE demand is purely inflationary
What are the causes of demand pull inflation
-exchange rate depreciation- exports
-reduction in taxes- consumption
-growth in money supply- consumption
-confidence- consumption + investment
-economic growth abroad- exports
What is cost push inflation
When increased costs of production, leads to upward shift in LRAS decrease, firms increase there prices to protect profits
What are the causes of cost push inflation
-rising import costs
-inflation in other countries
-depreciation of the pound
-rising wage costs
-rising indirect taxes
-supply side shocks
-exhaustion of natural resources
What is a wage price spiral
-Inflation
-Higher cost of living
-Workers demand higher wages
-Firms wage costs increase
-Firms have to increase prices
-Inflation
What is quantity theory
That the money supply has a direct and proportional relationship with the price level, excessive expansion of the money supply is inherently inflationary
What is the monetarist explanation of the quantity theory
The fisher equation
MV=PT
money supply x velocity of circulation = price level x output
V and T are fixed in the short run
What is an evaluation of quantity theory
-V and T are not stable so not a direct relationship
-If economy depressed V falls
-US after 2008 crisis money supply didn’t cause inflation
-Other methods of inflation like demand pull and cost push
What are the redistributive effects of inflation
Moves money from…
-Savers to borrowers, because value of repayments falls
-Employee to employer, because value of wages falls
-Employees and firms to gov, because of fiscal drag
What are the macro effects of inflation
-Cost push slows profits so less investment
-Interest rate increases so less growth
-Fall in value of pound so damaged international competitiveness
-Wage price spiral out of control
What are the efficiency effects of inflation
-Menu costs, changing prices
-Shoe leather costs, search times
-Distortion of price mechanism, inefficiency
Which inflation is considered more dangerous
Cost push because lowers GDP and causes unemployment unlike demand pull, also cannot be accessed by demand management policies like fiscal and monetary unlike demand pull
What is deflation caused by
Falling AD
Increase in productive potential causing excess supply
What are the problems of demand deflation
-Consumers hold back on spending
-Value of debt increases
-Real cost of borrowing increases
-Profit margins under pressure until costs fall further than price falls
-Falling asset prices has opposite wealth effect
Problems with tackling demand deflation
-It’s difficult to stimulate demand when there is high debt and falling asset prices
-It’s difficult to set interest rates below inflation when inflation is negative so can’t use monetary policy
-It’s difficult to use deficit spending due to high national debt
