3.4 Price stability Flashcards
• explain what is meant by price stability and inflation, including the difference between real and nominal values • explain how inflation is measured using the Consumer Price Index (CPI) • calculate the effect of inflation on prices • analyse recent and historical inflation figures • evaluate the causes of inflation and the consequences for consumers, producers, savers and the government
What does the term ‘price stability’ mean?
When the general level of prices stays constant over time, or grows at an acceptably low rate.
What does the term ‘inflation’ mean?
A sustained rise in the general price level over time.
What does the term ‘cost of living’ mean?
The price level of goods and services bought (by the average family).
What does the ‘rate of inflation’ mean?
The percentage rise in the general price level over time
What does the term ‘nominal value’ mean?
The value of something in terms of money
What does the term ‘real value’ mean?
The value of something in terms of money that takes inflation into account
What does the term ‘consumer price index (CPI)’ mean?
Method used to calculate the rate of inflation which is a survey that the government undertakes to determine the goods and service that average UK families spend money on called the ‘basket of goods’. It records the prices of all the goods and service at hundreds of different retail outlets and is recorded. It is accurate due to a system called ‘weighting’ giving certain items a specific weight.
What causes inflation?
- Too much demand (demand pull inflation)
- A rise in costs (cost push inflation)
- A wage-price spiral
What is ‘demand pull’ inflation?
When the total demand in the economy rises and the supply of goods and services does not increase to match, so the price level is pulled up.
What is ‘cost push’ inflation?
An increase in costs of production, which then leads to a rise in the price level in order to maintain profits which can be caused by productivity of labour, higher import prices and trade unions.
What is the ‘wage-price spiral’?
As the price level rises from inflation, the purchasing power of wages will fall and so workers will demand higher wages to compensate. Due to costs of production increasing, firms put up the prices and thus cost push inflation occurs even further.
What are the consequences of inflation for consumers?
- Loss of consumer confidence
- Shoe leather costs
- Real income may fall
- Consumers who are debtors gain (real value of debt falls)
- Income redistribution problems
What are the consequences of inflation for producers?
- More flexibility in setting wages and prices
- Menu costs
- Labour market conflicts
- Unemployment
- Producers lose as creditors
- Producers lack business confidence
What are the consequences of inflation for savers?
Inflation makes the purchasing power of money fall overtime. Therefore, if money is kept as savings, those savings will lose value in real terms in times of inflation
What are the consequences of inflation for the government?
- Gains as a debtor
- More spending on benefits
- More spending on employing labour
- More tax revenue
- Government policy needs to combat inflation
