3.3 inflation and deflation

Question 1

what is inflation

Answer 1

a rise in the general price level which leads to the devaluation of money

Question 2

what is deflation

Answer 2

a fall in the general price level- average prices are falling

Question 3

what is disinflation

Answer 3

a decline in the rate of inflation, prices are still rising but at a slower rate, eg 5%-3%

Question 4

how is inflation measured

Answer 4

changes in the consumer price index (CPI) who h measures the changes in the prices of a selection f household goods

Question 5

what does inflation look like I a healthy economy

Answer 5

low and stable

Question 6

what is the governments target for inflation

Answer 6

2%

Question 7

what are high rates o inflation damaging

Answer 7

creates uncertainty and undermines the price system,
money looses value quickly
lower growth and unemployment

Question 8

what is cost-push inflation

Answer 8

a rise in the costs of production that causes the SRAS curve to shift to the left, pushing up the prices to maintain profits

Question 9

what are the causes of cost-push inflation

Answer 9

increase in the national minimum wage 
trade unions increasing minimum wage
increase in the price of raw material 
external supply shocks 
rise in indirect taxation 
rise in cooperation tax 
falling productivity 
exchange rate depreciation, increasing the cost of imports

Question 10

what is demand-pull inflation

Answer 10

increased AD which the AS can’t keep up with so the prices are pulled up

Question 11

what are the causes of demand pull inflation

Answer 11

excessively ‘loose’ fiscal policy- income tax cut too much
excessively ‘loose’ monetary policy- interest rates cut too much
exchange rate depreciation-our exports cheaper
rising confidence- positive wealth effect from rising asset prices- houses
excessive borrowing
global economy experiencing faster growth in incomes and increasing their demand for uk goods + services causing AD to rise

Question 12

what are the consequences of high inflation on consumers

Answer 12

erodes the real value of money and real incomes fall
reducing living standards
inequality rises as skilled workers have more power to negotiate nominal wage increases
shoe leather costs - customers shopping around to find good prices
savers lose out as real interest rates fall
borrowers gain due to the fall in real interest rates
those in debt gain as they debt loses value

Question 13

consequences of high inflation on businesses

Answer 13

uncertain due to volatile prices leads to less investment
falling international competitiveness as exports are more expensive
menu costs- eg changing price lists and accounting procedure updates

Question 14

what are the role of expectations on inflation

Answer 14

if people expect inflation to rise they may send more now to avoid the future higher prices, this leads to a rise in AD which could push the price up even more

Question 15

what is a wage inflationary spiral

Answer 15

as inflation rises, workers ask for higher nominal wage, which increase business costs, which pushes up costs and prices further, so workers ask for a further rise, starting a spiral

Question 16

what are the consequences of deflation

Answer 16

unexpected deflation raises real interest rates which is bad for borrowers but good for savers
reduces the effectiveness of expansionary monetary policy
lower profit margins means less investment
can improve international competitiveness of exports
falling prices may cause consumers and firms to delay large items of investment - causes AD to fall further - creating a spiral

Question 17

what is malign deflation

Answer 17

a significant fall in aggregate demand, it is accosted with a severe recession, like the Great Depression in the 1930’s

Question 18

what is benign deflation

Answer 18

a significant and prolonged fall in the costs of production, usually associated with technological development, eg the industrial revolution

Question 19

what do monetarists believe inflation is caused by

Answer 19

an increase in the money supply = shown in the quantitive theory of money

Question 20

what does the quantitive theory of money explain

Answer 20

the links between the money supply and the general price level, it is based on the fisher equation

Question 21

what is the fisher equation

Answer 21

Money Supply (M) X Velocity of the circulation of money (V)
= price level (P) X real GDP (Q)

MV=PQ

Question 22

what does the fisher equation tell us

Answer 22

if velocity is constant then a percentage rise in the money supply will have an equivalent percentage rise in nominal GDP (price level X GDP)