3.3 Macroeconomic Objectives — Low And Stable Rate Of Inflation

Question 1

what is inflation

Answer 1

Sustained increase in the general price level

Question 2

what is deflation

Answer 2

Sustained decrease in the general price level

Question 3

what is disinflation

Answer 3

A decrease in the rate of inflation

Question 4

how is inflation measured

Answer 4

CPI - consumer price index

Question 5

what is CPI

Answer 5

A measure of the cost of living for the typical household, and compared the value of a basket of goods and services in one year with the value of the same basket in a base year

Positive percentage indicates inflation

Negative percentage indicates deflation

Question 6

How to calculate a price index for a specific year

Answer 6

Question 7

How to use price index to calculate inflation

Answer 7

(Price index for final year - price index for initial year) / price index for initial year * 100

Question 8

limitations of CPI

Answer 8

• Cannot measure changed in product quality
• Different rates of inflation depending on regional or cultural factors
• different rates of inflation for different income earners
• changes in consumption patterns due to consumers substitutions when prices change

Question 9

causes of inflation

Answer 9

Demand pull inflation

Cost pull inflation

Question 10

Explain demand pull inflation + the graph

Answer 10

Caused by increases in AD

Question 11

Explain cost push inflation + graph

Answer 11

Caused by a fall in AS, can be from increased wages or price of other inputs

Question 12

Cost of high inflation

Answer 12

Redistribution effects - takes income from certain groups to others -workers on fixed incomes are worse off - holders of cash are worse off - saves are worse offs - lenders are worse off - borrowers gain - payers of fixed income gain

Uncertainty - Firms may reduce investment due to uncertainty about future prices as they cannot predict revenues

Effects on savings - if inflation is higher then interest rate savers lose money, lowering incentive to safe

Export competitiveness- if a country has a higher inflation rate then their trading partners, then their exports would become less attractive as they are more expensive

Effects on economic growth - fall in investment and lower savings means less funds for investment + decreased exports

and higher imports all - contributed to fall in AD
Effects on resource allocation - if prices rise rapidly, the signaling and incentive functions do not work effectively

Question 13

Causes of deflation + show graph

Answer 13

Decreases in AD

Decreases in AS

Question 14

Costs of deflation

Answer 14

Redistribution effects - individuals on fixed incomes, savers and lenders all gain, while borrowers and payers of fixed incomes lose as they pay more

Increase in real value of debt

Uncertainty - firms are unable to forecast costs and revenues
Deferred consumption, high and increase cyclical unemployment - consumers postponed spending, deflation discourages borrowing resulting in reduced spending - AD falls and furthers cyclical unemployment - economy falls into deflationary spiral

Risk of bankruptcies and financial crisis - as consumes and firms are unable to repay debts

Insufficient resource allocation - prices of
G&S do not gall accordingly, price signals and incentives get distorted

Question 15

What is stagflation

Answer 15

slow economic growth accompanied with rising prices (inflation), and rising unemployment