4.2.3.3 - Inflation

Question 1

Define inflation

Answer 1

A continuous increase in the general price level over time. Meaning the purchasing power of money decreases

Question 2

Define deflation

Answer 2

A continuous fall in the general level of price per time where the inflation rate is negative

Question 3

What is disinflation

Answer 3

When the rate of inflation is falling but still positive, the average price level rises but much slower than in the years before

Question 4

What is creeping inflation

Answer 4

A slow and steady rise in pries over a number of years

Question 5

What is hyper inflation

Answer 5

Large increases in the general price level by 50% or more per month. The store value of money fails to hold

Question 6

What is demand pull inflation

Answer 6

When inflation occurs due to a shift in AD
- this is because there is an unsustainable rate of AD meaning AD exceeds AS causing a rise in general prices

Question 7

What is cost push inflation

Answer 7

When inflation is caused by a shift in AS
- when the increased costs of production leads firms to increase their prices in order to maintain a steady output level

Question 8

What is consumer price index

Answer 8

CPI
- a family expenditure survey carried out to judge average spending habits
- it is regularly updated and is measured representative basket of goods
- it attached weights to each item in the basket based on its importance in people’s spending

Question 9

What is a limitation of CPI

Answer 9

• household households experience different rates of inflation
• it doesn’t recognise the quality of the gods and services in the basket
• its slow to respond to new products

Question 10

What is the real price index

Answer 10

• includes mortgage interest repayments And council tax
• tends to be a higher value than CPI
• excludes the top and bottom 4% of earners
• it was discredited as an accurate figure as the mortgage payments distort the figure

Question 11

What is CPIH

Answer 11

Consumer price index + housing
- adds owner occupier housing costs and council tax to CPI
- it is otherwise calculated in the same way with CPI with the same basket of goods

Question 12

What are the 3 causes of inflation

Answer 12

• demand pull
• cost push
• growth of the money supply

Question 13

What are reasons for demand pull inflation occurring

Answer 13

• reduced taxation
• lower interest rates
• high consumer confidence
• increase in incomes
• weak exchange rate
• fast growth in other countries ( increases demands for export)

Question 14

What are some reasons cost push inflation can occur

Answer 14

• wages increase
• higher raw material costs
• higher taxes
• higher import prices
• external shocks

Question 15

How does a growth in the money supply occur

Answer 15

• the quantity theory of money states that growth of the money supply leads to inflation
• an increase in prices would therefore solely be sue to an increase in the money supply

Question 16

What is the quantity theory of money

Answer 16

The fisher equation is used to demonstrate the changes in price level:
MV=PQ
(Money supply)(velocity of circulation) = (average price level)(national income/output/expenditure)

Question 17

How can he fisher equation be used to isolate the impact of changes on price

Answer 17

P = MV/Q
- because Q and V are constant, only M can influence prices, so if there is more money chasing the same amount of goods, there will be inflation

Question 18

What are some issues with the quantity theory of money

Answer 18

• changes in the velocity of circulation & national income/output/expenditure can occur- potentially leading to inflation. despite being presented as constant
• demand pull and cost push inflation isn’t included in the equation
• the money supply is difficult to quantify

Question 19

How you increase the money supply

Answer 19

• print more money via the Bank of England
• reduce deposit holdings of banks allowing them to led more money
• use quantitive easing

Question 20

What is quantitive easing

Answer 20

an unconventional form of monetary policy:
- QE involves the introduction of new money into the national supply by a central bank
- this new electronic money is used to buy assets (mainly bonds) from financial institutions such as insurance companies, pension funds and commercial banks

Question 21

What are bonds

Answer 21

Fixed income financial assets that provide the holder with a stream of income on an annual basis, they are commonly used by the government as a way to borrow money

Question 22

What is the yield of a bond

Answer 22

The interest as a % of the market price

Question 23

What us the relationship between the market price of a bond and its yield

Answer 23

There is an inverse relationship, as the market price increases, the yield of the bond falls as it is minimises by the larger value

Question 24

How does QE impact the economy (11 steps)

Answer 24

1) new electronic money is created by the central bank
2) this is used to but assets (eg: bonds)
3) this increases the price of bonds and causes yields to fall
4) financial institutions sold bonds and have more ‘cash’
5) there is now more liquidity in the financial sector
6) greater liquidity may incentivise financial institutions to lend more
7) lower yields mean lower interest rates
8) there is more, and cheaper credit so both I and C rise
9) as bond prices rise there is a positive wealth effect
10) lower interest rates end to depreciating currency so (X-M) rises
11) leading AD to rise

Question 25

What is the wealth effect

Answer 25

Lower yields lead to higher share and bond prices

Question 26

What is the leading effect

Answer 26

QE increases the liquidity of banks and increased lending from banks, lifts incomes and spending in the economy

Question 27

What is the currency effect

Answer 27

Lowers interest rates has the side effect of causing the exchange rate to weaken which helps exports

Question 28

Which are the stakeholders effected by inflation

Answer 28

• banks
• savers
• companies
• consumers
• borrowers
• labour
• exporters

Question 29

What are the costs of inflation on th economy

Answer 29

• reduced confidence ad therefore investment and consumption decreases
• real value of savings decrease so there is a disincentive to save
• income is redistributed from savers to borrowers, real value saving falls and so does the real value of debt
• consumers and businesses on fixed incomes lose out so inequality could rise
• harms trade so reduces uk competitiveness

Question 30

What are the consequences of deflation

Answer 30

• there is a hold back on sending as people may expect prices to fall lower
• the real cost of borrowing increases so debt increases
• lower profit margins
• wealth decreases and hits confidence - firms investments may decrease

Question 31

How do changes in other economies affect inflation in the UK

Answer 31

• emerging markets creating growing demand causes demand pull inflation due to the increased exports
• increasing productive capacity in emerging markets leads to lower production costs, so prices are lowered

Question 32

What is benign deflation

Answer 32

When prices are falling due to improvements in productivity which lowers costs

Question 33

Malign deflation meaning

Answer 33

Caused by persistent low levels of AD so impacts are more severe

Question 34

What are the benefits of inflation

Answer 34

• Debts can be payed off
• sustainable growth cab occur

Question 35

What is core/ underlying inflation

Answer 35

• Measure of inflation without volatile values such as energy and food
• gives a better understanding of what true inflation is looking like