2.1.2 Inflation

Question 1

What is inflation

Answer 1

a sustained increase in general price level

Question 2

Does inflation lead to an increase or decrease in PPP

Answer 2

decrease

Question 3

What is inflation measured in

Answer 3

annual percentage change in consumer price index

Question 4

What is the target set by the government for inflation using CPI

Answer 4

2%

Question 5

How does the bank of England control inflation

Answer 5

monetary policy base interest rates

Question 6

What is deflation

Answer 6

a fall in general price level ‘negative inflation’

Question 7

What is disinflation

Answer 7

a slowdown in the rate of increase of price

Question 8

Which countries had the highest rates of inflation in 2018

Answer 8

Venezuela
South Sudan
Sudan

Question 9

What is Consumer price index

Answer 9

• A base price is selected
• Family expenditure survey is carried out
• representative basket of 600 goods/services is used, and each good is weighted based on importance
• Weights are then multiplied by price changes and weighted price changes are totalled to calculate inflation rate

Question 10

5 Limitations of CPI as a measure of inflation

Answer 10

• CPI is not fully representative, e.g. for a non typical household
• Spending patterns
• Changing in quality of good/services
• New products, its slow to react to new products + services
• Doesn’t account for regional difference in cost of living

Question 11

What is hyperinflation

Answer 11

a period of high rates of inflation, usually leading to a loss of confidence in an economy currency

Question 12

Unit labour cost

Answer 12

Reflect total labour costs, including social security + employers’ pension contributions

Question 13

Domestic causes for inflation

Answer 13

inflationary pressures within domestic economy

i.e. rising wage cost and increased costs of components parts of raw material

Question 14

External causes for inflation

Answer 14

These are inflationary pressures outside of a particular country
i.e. increase in global prices/cost of energy
Or movements in a countries exchange rates
i.e. if a currency weakens that will mean imported goods will be more expensive, pushing up domestic production costs

Question 15

Why are inflation expectations important

Answer 15

Once inflation is established it is hard to remove
Most agents will raise their inflation expectations and build it in to their calculations and decisions
A rise in inflation can lead to a rise in inflation expectations, which can feed through higher wage claims and rising costs

Question 16

Cost-Push inflation

Answer 16

• Rising costs in the labour market and increasing costs from domestic and oversea suppliers (which is offset onto consumers)
• or supply decreases usually output of Rising import prices due to a falling exchange rate
• goods/services and employment tend to fall because a rise in cost often leads to a fall in business profits and planned investment spending
• Causing inelastic demand

Question 17

Demand pull inflation

Answer 17

occurs when total demand for goods/services exceeds total supply
As economy approaches full employment (or capacity) labour and raw materials shortages occur more frequently, meaning firms cant expand production
When demand rises, it encourages the produces to raise their prices to increase profit margin

Question 18

Growth of money supply

Answer 18

when money supply increase quicker than economy’s growth rate can lead to inflation

Question 19

Fisher Formula

Answer 19

MV=PT 
M=money supply
V= velocity of money i.e. how long it takes to move through market 
P=price level 
T=volume of output

Question 20

4 Winners from rising inflation

Answer 20

• Workers with strong wage bargaining power, like trade unions
• debtors, if real interest rates on loads are negative
• Producers if their prices rise faster than costs
• Wealthy groups if their is a sustained period of asset price rise

Question 21

5 Losers from inflation

Answer 21

• retired people on fixed incomes, inflation erodes real value of savings
• lenders if real interest rates on loans are negative
• Savers
• Workers in low paid jobs
• Exporting firms

Question 22

4 Risks of high and volatile inflation

Answer 22

• Inequalities
• Falling in real income/wage inflation
• Negative real interest rates/decrease in borrowing
• Business uncertainty

Question 23

Causes of deflation

Answer 23

• Demand-side causes deflation, deep fall total demand and high spare capacity
• Supply-side, total, supply in economy rises more than demand

Question 24

3 Countries with lowest inflation in 2018

Answer 24

St. Kitts and Nevis
Ecuador
Djibouti

Question 25

5 Economic effects of deflation

Answer 25

• Holding back on spending (confidence), meaning lower profit margins for businesses
• Debt/interest/borrowing increases
• Income distribution
• Deflation makes exporters more competitive