3.4 Price Stability

Question 1

price stability

Answer 1

when the general level of prices stays constant over time, or grows at an acceptably low rate

Question 2

inflation

Answer 2

sustained rise in the general price level over time

Question 3

nominal vs real values?

Answer 3

nominal - value of something in money terms
real - takes inflation into account - refers to goods and services that can be bought with that wage

Question 4

(cost of living)

Answer 4

price level of goods and services bought (by the average family)

Question 5

(rate of inflation)

Answer 5

percentage rise in general price level over time

Question 6

consumer price index (CPI)

Answer 6

method used to calculate the rate of inflation (government undertakes a survey to determine g+s average UK family buys - ‘basket’ of g+s - records prices every month - given number 100 initially and price change will be reflected)

Question 7

causes of inflation

Answer 7

• too much demand (demand pull inflation): caused when the aggregate demand in the economy rises and the supply of g+s does not increase to match the increase in demand, so the price level is pulled up. demand surplus often comes from consumers, especially in times of a boom, but can come from other parties also
• rise in costs (cost-push inflation): caused by higher costs in production that lead to a rise in the price level, e.g. wages, materials, rent, interest, to maintain profits, firms will raise prices - main cost = wages

Question 8

consequences of inflation for consumers?

Answer 8

• loss of consumer confidence: consumers use money as a medium of exchange to buy + sell g+s - stable prices mean consumers know the relative costs of g+s, enabling them to plan their spending + save - inflation = changing money value = loss of confidence
• shoe leather costs: prices change more often = consumers spend extra time and effort looking to purchase goods (shoe leather costs) as are less sure to diff prices of market
• real incomes may fall: inflation affects their limited income - fallen standard of living as unable to afford same g+s as before
• debtors gain: real value of debt goes down = cheaper debts
• income redistribution problems: savers lose, debtors gain, some workers are able to achieve wage rises, others, e.g. low fixed income workers face hardship

Question 9

consequences of inflation for producers?

Answer 9

• more flexibility: some inflation in a rowing economy allow greater flexibility because it is easier for relative prices to adjust, particularly wages, e.g. trade unions may accept a wage rise (e.g. 2%) that does not keep up with a low inflation rate (e.g. 3%) which they otherwise would not have allowed - helps producers remain competitive + may be easier to increase prices as consumers are less likely to notice = increase profits
• menu costs: firms have to adjust price lists + capital equipment = increase costs
• labour market conflicts: if producers (often facing rising costs + falling sales) are unable/unwilling to give a wage rise on par with inflation to workers = conflict, e.g. strikes
• unemployment: makes economy less competitive = less sales/output/workers needed -> cyclical unemployment?
• lose as creditors: repaid loans real value is lower
• lack business confidence: less likely to invest if they have greater uncertainty about the future - adversely affect economic growth

Question 10

consequences of inflation for savers?

Answer 10

• value of savings fall

Question 11

consequences of inflation for government?

Answer 11

• gains as a debtor: usually a net borrower, and real value of debts/loans decrease
• more spending on benefits: will rise in line with inflation
• more spending on employing labour: faces demand for wage rises
• more tax revenues: automatically receive higher revenues
• policies required to combat inflation