3.4 Price Stability

Question 1

What is price stability?

Answer 1

When the general price level either stays the same or rises at a low rate over time.

Question 2

What is inflation?

Answer 2

When the general price level increases over time.

Question 3

What is the rate of inflation?

Answer 3

It is the percentage rise in general level of prices over time (usually a year). It is always a positive number.

Question 4

What is the difference between real and nominal values?

Answer 4

Real values take into account the rate of inflation, whereas nominal values do not.

Question 5

How is inflation measured?

Answer 5

Through the Consumer Price Index (CPI).

Question 6

What is the process of CPI?

Answer 6

• Consumers are surveyed to create a basket of goods and services that they are buying
• Products are weighted, meaning that if higher amounts are bought, they are given more importance
• CPI then checks the prices every month

Question 7

How does the CPI find the inflation rate?

Answer 7

Index numbers show the overall change in general price level compared to the base year (where the CPI is set at 100). Any numbers above 100 shows that inflation has risen.

Question 8

How do you calculate a change in price due to inflation?

Answer 8

(Original price ÷ 100) × inflation rate

Question 9

How do you calculate a new price after inflation?

Answer 9

Original price × multiplier for the inflation rate

Question 10

When do price levels only fall?

Answer 10

When the inflation rate is below zero.

Question 11

What is demand-pull inflation?

Answer 11

When total demand rises faster than total supply in a country.

Question 12

Why and how does demand-pull inflation occur?

Answer 12

• Increased incomes
• Excess printing of money

Leads to increased competition for these goods and services pushing prices up.

Question 13

When does demand-pull inflation usually happen?

Answer 13

This occurs when an economy is operating close to its productive capacity, so it is difficult to respond quickly to increased demand. Being nearly at full employment can also make it harder to find more workers to produce more output.

Question 14

What is cost-push inflation?

Answer 14

It is caused by a rise in the costs of production which firms try to pass on to consumers to maintain profits. This leads to a general rise in price.

Question 15

What are three examples of costs of production?

Answer 15

• Wages
• Import prices on raw materials
• Interest on borrowing

Question 16

What is cost-push inflation caused by?

Answer 16

• Increase trade union power = higher wages for workers
• Fall in exchange rate = higher import prices (on raw materials)

Question 17

How can a wage-price spiral worsen inflation?

Answer 17

Because of inflation, workers demand higher wages. Workers get their higher wages, but costs of production rise and are passed onto the consumer. This increases inflation and the cycle repeats.

Question 18

What is purchasing power?

Answer 18

Refers to how much you can buy with your money.

Question 19

What are two consequences of inflation for savers?

Answer 19

• Inflation reduces the real value of money saved and its purchasing power
• It reduces the impact of any interest

Question 20

How do you calculate the real rate of interest?

Answer 20

Nominal rate of interest - inflation rate

Question 21

What are three consequences of inflation for the government?

Answer 21

1. Inflation puts pressure on the government to increase wages for employees such as NHS staff. This increases government spending.
2. Tax revenue can increase on VAT as it is a percentage of higher prices. However, fixed taxes (like on alcohol) can fall in real terms.
3. Real value of national debt can fall.

Question 22

What are three consequences of inflation for consumers?

Answer 22

• Loss of consumer confidence: uncertainty with rising prices can stop consumers buying products
• Can cause a fall in real income, meaning consumers will have less purchasing power
• If consumers have borrowed money, the real value of the debt falls

Question 23

What are three consequences of inflation to producers?

Answer 23

1. Increased production costs due to inflation raising price of inputs
2. Firms may incur more costs as they have to increase worker pay because of inflation.
3. If inflation in the UK is higher than overseas, UK goods will be seen as expensive and people will buy less. This will lead to lower exports.