3. Inflation

Question 1

2 Ways to Measure Inflation

Answer 1

1. Consumer Price Index (CPI)
2. Retail Price Index (RPI)

Question 2

Limitations to Inflation Measurement

Answer 2

1. Each household experiences different inflation
2. Gov. measure inflation with CPI, this excludes mortgages
   For many households, mortgage. is biggest expenditure but is excluded by CPI

Question 3

Disinflation

Answer 3

The inflation rate is still positive but falling, therefore prices still rise but at a slower rate

Question 4

Deflation Definition and Causes

Answer 4

A decrease in the general price level

Happens in very low or stagnant growth. Despite fact that money value rising, demand very low. As prices fall, consumers tend to delay payments due to beliefs of prices falling even more. Consumption falls significantly. Firms lose confidence to invest. AD goes down

Question 5

Stagflation Definition and an Example

Answer 5

Weak economy, high unemployment, high inflation.
An example is Germany in 1923 due to hyperinflation. Printed money, more money in circulation, value went down. There were also striking workers, thus economy less productive.

Question 6

3 Primary Causes of Inflation

Answer 6

Demand-Pull
Cost-Push
Growth of money supply

Question 7

Demand-Pull Inflation

Answer 7

Caused by excessive demand.
There is too much money chasing too few goods and services.
Leads to a rise in AD

Question 8

Causes of Demand-Pull Inflation

Answer 8

Reduced tax-people have more income
Lower Interest Rates- Borrowing more attractive and saving less rewarding
General rise in consumer spending-Higher incomes and higher confidence
Weak exchange rate-Boost export growth
Fast growth in other countries-May demand UK exports

Question 9

Cost-Push Inflation

Answer 9

Occurs when firms respond to rising costs of production by increasing prices.
This is to protect profit margins.
Firms may be able to absorb some increases to cost of production, but this cannot be done indefinitely, so cost may passed on to consumers of a higher price.

Question 10

Causes of Cost-Push Inflation

Answer 10

Wage increases- For many firms, wages biggest cost. If prices rise, workers want more pay to survive. If higher wage costs reflected in higher prices then workers will continue to demand higher wages, leading to a wage-price spiral.
Higher raw material costs-Materials more scarce so demand higher.
Higher taxes
Higher import prices
Natural disasters.

Question 11

Growth of Money Supply

Answer 11

A measure of the amount or stock of money in the economy
As economy grows every year it is likely that we need a higher supply of money due to more transactions

Question 12

2 Money Supply Definitions

Answer 12

1. M0 is known as narrow money and includes notes and coins in circulation and some other liquid assets
2. Broad money e.g M4 includes a wider definition of money including M0, bank account deposits and other liquid assets

Question 13

Quantitative Easing

Answer 13

When recession began in 2008, the BoE would have been expected to cut interest rates in order to help stimulate economic activity.
However, with interest rates at 0.5%, they had very little downwards movement to manipulate the economy with.
In addition, banks were nervous about lending money to firms and individuals, so BoE sought to boost the funds available for lending to businesses and firms

Question 14

Effects of Inflation

Answer 14

High inflation will lead to consumers purchasing goods and services today before prices rise even further.
Firms will pass costs on to consumers through increased prices, thus fuelling more inflation.
Gov. have set the BoE a remit of maintaining the CPI at 2% (+/-1%) so interest rates might change to control the price level.
Workers will bargain to increase wages.