2.5 External Influences Flashcards
inflation
a sustained increase in the average price level of an economy
demand
how much of a good or service a consumer wants and is able to pay for
what is GDP
measure of the value of output (goods produced) in the economy
its a value used to assess changes in economic growth
what is real GDP
is a sustained increase in the average price level of an economy
how is the rate of inflation measured
the annual percentage change in the level of prices as measured by the consumer price index (CPI)
what is deflation?
sustained fall in the general price level. in this situation the rate of inflation becomes negative
what is the bank of England’s target for inflation? and why?
2%
to achieve a sustained period of low and stable inflation. price stability
two main causes of inflation
- demand pull - when there is excess demand
- cost push -when costs rise
when does cost push inflation occur
Occurs when costs of production are increasing
Causes of cost push inflation
- External shocks (e.g. commodity price fluctuations)
- A depreciation in the exchange rate
- Acceleration in wages
What happens during cost push inflation
- Firms raise prices to protect their profit margins – better able to do this when market demand is price inelastic
- “Wages often follow prices”
- A rise in inflation can lead to rising inflationary expectations
when does demand pull inflation occur? what do businesses do during it
Occurs when there is excess aggregate demand in the economy or market
Businesses respond to high demand by raising prices to increase their profit margins
Demand-pull inflation is associated with
the boom phase of the business cycle
Possible causes of demand pull inflation
- A depreciation of the exchange rate
- A reduction in direct or indirect taxation
- Rising consumer confidence and an increase in the rate of growth of house prices
- Faster rates of economic growth in other countries
A depreciation of the exchange rate as a cause
A depreciation of the exchange rate increases the price of imports and reduces the foreign price of UK exports
A reduction in direct or indirect taxation as a cause
A reduction in direct or indirect taxation - consumers have more disposable income causing more demand
Faster rates of economic growth in other countries as a cause
providing a boost to UK exports overseas
A rise in general inflation:
- Sales revenue should rise
- But workers likely to demand higher pay to compensate for consumer price inflation
- Labour intensive industries more at risk
Input cost inflation
- Cost-push inflation will vary from industry to industry
- Firms that need to buy significant commodity raw materials may find profit margins squeezed if they cannot pass on increased costs to customers
business effects of inflation
- Industry-wide price rises enable revenues to grow
- Growing revenues + constant gross margin = higher gross profit
- Makes using debt as a source of finance cheaper in real terms
what is the trade cycle
level of economic activity fluctuates over time
what is real income
real income measure the amount of disposable income available to consumers (e.g. household’s/individuals)
factors that affect consumer spending:
- real disposable income
- employment and job security
- household wealth
- expectations and sentiments ( economic uncertainty causes spending to fall, weakening demand)
- market interest rate
what are interest rates?
the reward for saving and cost of borrowing expressed as a percentage of the money saved or borrowed
