2.4 inflation Flashcards

1
Q

define inflation

A

a sustained increase in the average price level. the rate of change of the average pice level - the % annual rate of change of the consumer price index

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2
Q

define disinflation

A

a fall in the inflation rate. it means that the general price level is increasing at a slower rate

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3
Q

define deflation

A

when there is actually a fall in the average PL (negative inflation)

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4
Q

define hyperinflation

A

a rapis and unchecked increase in the PL. typically it involves inflation rates of greater than 50% or even greater than 1000%

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5
Q

explain the policy objective of low/stable inflation

A

attempts to create stability in the overall equilibrium PL. gov’s target is 2% (CPI)

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6
Q

why is the target of low and stable inflation important

A

high/volatile inflation may deter firms from investing and therefore hinder EG. firms base investment decisions on future expectations. inflation makes it hard to form reliable expectations for the future. a stable macro environment is crucial for EG to happen

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7
Q

define nominal values in the context of inflation

A

the unadjusted rate or current price, without taking inflation into account

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8
Q

define real values in the context of inflation

A

adjustments are made for general PL changes (inflation) over time

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9
Q

how to calculate index numbers

A

current value of index = (current value/base value) x 100 –> to compare 2 years not including the base year calculate % change

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10
Q

how do we measure inflation

A

consumer prices index (CPI) and the retail prices index (RPI) - two baskets comprising different goods and services. both weighted price indexes based on how often goods are bought - changes in weight reflect shifts in spending patterns as measured by the family expenditure survey

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11
Q

difference between cpi and rpi

A

rpi includes housing costs like mortgage interest payments and council tax but cpi doesn’t

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12
Q

detail about the cpi

A

inflation rate is calculated each month by looking at changes in prices for over 700 goods and services in 150 different areas in the UK. known as the basket of goods and is regularly updated to reflect changes

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13
Q

how to calculate a weighted price index for this year

A

the sum of (price x weight)/ sum of the weights

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14
Q

how to calculate rate of inflation

A

the % change in price index from one year to another

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15
Q

advantages of using cpi and rpi to measure inflation

A

large categories make cpi a legit indicator, measurable (quantifiable)

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16
Q

disadvantages of using cpi and rpi to measure inflation

A

few households are exactly average, not fully representative of all households, different people have different spending patterns, new products may not be accounted for as the cpi is slow to respond to new products or services

17
Q

name the causes/types of inflation

A

demand pull, cost push

18
Q

explain demand pull inflation

A

higher aggregate demand pulls prices up. ad shifts to the right

19
Q

explain cost push inflation

A

supply decreases because costs of production have increased. can be caused by higher wages, higher raw material prices, higher business taxes, higher cost of imports due to a weaker exchange rate. sras shifts to the left, increasing the PL

20
Q

why should there be a persistent price increase over time

A

a moderate rate of inflation is consistent with a steady rate of EG

21
Q

name consequences of inflation

A
  1. fall in the value of money - falling real incomes
  2. menu costs
  3. shoe leather costs
  4. inflationary noise/impact on resource allocation
  5. impact on inequality
  6. fiscal drag
  7. uncertainty and investment
  8. loss of international competitiveness
22
Q

explain 1. fall in the value of money - falling real incomes

A

money can now buy less than it could the year before because of inflation as it’s worth less. consumers can buy less

23
Q

explain 2. menu costs

A

restaurants constantly having to reprint menus due to changes in prices

24
Q

explain 3. shoe leather costs

A

the cost of having to move money between different financial institutions to try and minimise the impacts of inflation (i.e having to carry your money and ‘walk’ to a different financial institution thus wearing out the leather of your shoes)

25
Q

explain 4. impact on resource allocation

A

price usually acts as a way to decide where resources are allocated. inflation may mean it can’t reliably do this so resources are misallocated and business opportunities may be lost

26
Q

explain 5. impact on inequality

A

some groups in society will be less able to protect themselves against rising prices so this increases inequality. eg pensioners and those on fixed incomes now have less buying power because their incomes/savings are diluted by rising prices and so they are some of the most disadvantaged

27
Q

explain 6. fiscal drag

A

inflation means higher wages means people are in a higher tax bracket meaning they may be worse off as are losing more money to taxation

28
Q

explain 7. uncertainty and investment

A

if firms can’t confidently say what the rate of inflation will be in the future this increases their uncertainty. more uncertainty can make them reluctant to undertake investments to increase their productive potential as they don’t know if demand will be high enough in the future to justify this

29
Q

explain 8. loss of international competitiveness

A

higher inflation in a country may make other countries less inclined to buy goods from them as they’re more expensive so they buy goods from other countries instead

30
Q

the benefits of inflation

A

low and stable demand pull inflation may encourage firms to increase their output, workers may feel more appreciated if their wages increase even if real pay doesn’t, allows firms to cut real wages - improving labour markets

31
Q

evaluate the significance of inflation

A

the impact of it depends on the rate, the cause, the fluctuations, and the comparison with other economies. low stable rate is generally okay. cost push is more harmful as it usually leads to a fall in real gdp

32
Q

why might deflation be economically damaging

A
  1. holding back on spending if consumers think it will be cheaper in future
  2. debts increase
  3. the real cost of borrowing increases
  4. lower profit margins
33
Q

causes of deflation

A

falling ad, lower production costs