2.4 Inflation

Question 1

What is inflation?

Answer 1

A general sub stained increase in the price of goods and services.

Question 2

What is deflation?

Answer 2

A general and sub stained fall in the price of goods and services.

Question 3

What is disinflation?

Answer 3

A drop in the rate of inflation. (Price increase at a slower rate.)

Question 4

What is the inflation rate?

Answer 4

The rate of change of prices over a set time period usually a quarter.

Question 5

What is consumer price index? (CPI)

Answer 5

A measure of the general price level of goods in the UK based upon 650 common household goods.

Question 6

How is the CPI created?

Answer 6

• Family expenditure survey
• Price survey

Question 7

How is the price survey conducted?

Answer 7

Using the price of 650 most commonly used goods and services an average is found to give a price index.

Question 8

How is the family expenditure survey conducted?

Answer 8

Using the sample size of 7000 households they are asked what they spent on categories of goods including clothes and food. Then this information is used to give each category a ‘weight’.

Question 9

What is the retail price index? (RPI)

Answer 9

Retail price index is used to measure inflation based om the percentage change in the cost of a basket of commonly consumed retail goods.

Question 10

What are the problems with CPI?

Answer 10

• Unrepresentative of certain groups
• Sampling problems
• Changes in consumer tastes
• substitute effect not accounted for
• quality changes mean not comparing like for like
• mortgage interest repayments not included

Question 11

What are the problems with RPI?

Answer 11

• Takes into account mortgage interest repayments making inflation look worse than it is.

Question 12

What are the costs of inflation?

Answer 12

• Increases times spent for consumers to purchase goods as researching price standards.
• Consumers on fixed incomes money is now worth less.
• A wage price spiral may begin in response to a rise in prices demand higher wages increasing unemployment.
• Volatile inflation makes long term business planning difficult.

Question 13

Why do we not aim for 0% Inflation?

Answer 13

• 0% inflation is very difficult to achieve.
• Inflation reduces the cost of borrowing and will increase investment.
• Inflation allows companies to reduce their costs by not rising wages in line with inflation meaning they can higher more workers for the same real price.

Question 14

Why is deflation bad?

Answer 14

• Decreased consumer spending due to people waiting for prices to drop further
• Demand dropping may lead to salary cuts and layoffs leading to high unemployment
• Higher cost of borrowing