4.8- Inflation and deflation

Question 1

What causes Inflation?

Answer 1

Demand pull inflation: When the price levels increase due to aggregate demand exceeding aggregate supply. Excess demand leads to higher prices as suppliers increase prices to balance supply gap causes inflation

Cost push inflation: When the price level increases due to the increases in cost of production for firms and businesses, causing them to pass on the increased cost to consumers in form of higher prices.

Question 2

What is Inflation?

Answer 2

A sustained increase in the general price level of goods and services in the economy over a period of time

Question 3

What is Disinflation?

Answer 3

A fall in the rate of inflation.

Question 4

What is Deflation ?

Answer 4

A decrease in the general price level of goods and services in an economy

Question 5

What are some of the impacts of inflation and who do they impact ?

Answer 5

Workers: if wages do not increase at the same rate of inflation real wages (adjusted for inflation) decrease, reducing purchasing power.

Firms: increase cost for raw materials, higher wages or energy cost reduce profit margins if these cost increases cannot be passed on to consumers through higher prices.

Consumers: Inflation erodes the purchasing power of money over time, as more money is needed to buy the same goods and services.

Economy: If a country’s inflation rate is above that of its rivals, its products will be less price competitive this may result in a fall of export revenue and a rise in import expenditure.

Question 6

What are more consequences of inflation and who they impact?

Answer 6

Savers: if the rate of inflation exceeds the interest rate, stored money is effectively losing future purchasing power.

Renders: Inflation can erode the real value of the interest income recived especially if the interest rate is low.

Economy: inflation can introduce uncertainty and reduce confidence

Question 7

How does Demand pull cause inflation?

Answer 7

Demand pull is where the price level increases due to aggregate demand exceeding aggregate supply total aggregate demand is the sum of all expenditures

Question 8

How can Demand cause an increase in the general price level for goods

Answer 8

If any of the four components of aggregate demand increase there will be an increase in the total demand in the economy leading to an increase in the general price level.

Question 9

How can cost push cause inflation?

Answer 9

Cost push inflation is when the price level increases due to the increases in cost of production in the economy.

Question 10

How can supply push cause an increase in the general price level of goods.

Answer 10

If any of the cost of production increases or if there is a fall in productivity total supply will decrease with less supply prices will rise leading to an increase in the general price level.

Question 11

What policies can be used to control Cost push inflation?

Answer 11

The government can use supply side policy measures to increase the productive potential of the economy as this allows the economy to grown in a non inflationary way
For example spending on education and training makes workers more skilled and productive ultimately lowering the cost of production for firms.
The government may also use subsidies certain industries to help with growing cost of production and bring down the price level.

Question 12

What policies can be used to control Demand pull?

Answer 12

Contractionary monetary policy includes raising intrest rates to increase the reward for saving, reducing consumption firms will also have less incentive to invest as the cost of borrowing money will be higher both will reduce aggregate
Contractionary fiscal policy includes decreasing government expenditure which reduces a component of aggregate demand.
Raising income tax reduces the amount of disposable income for consumers to spend raising corporation tax reduces the profit levels firms have to reinvest into their business and the wider economy both of which reduces aggregate demand

Question 13

How does inflation effect firms

Answer 13

Uncertainty: Rapid price changes create uncertainty and delay investment
Menu change cost: price changes force firms to change their menu prices too this can be expensive
Lenders financial firms that lend money are worse off as the money lent out is now worth less than before

Question 14

How does Inflation effect consumers

Answer 14

Purchasing power: decreases which worsens the quality of life for consumers as they spend a higher proportion of their disposable income on necessities rather then luxuries

Savings: There is a decrease in the value of savings as their money will be worse less and won’t be able to spend it saved money often spent on luxuries

Real income: There is a fall in real income for those on fixed incomes

Borrowers: anyone who borrows money will benefit as the repayments are worth less than when the money was originally borrowed

Question 15

How does inflation effect the Government

Answer 15

International competitiveness: inflation erodes international competitive ness of exports as their products now look more expensive

Trade offs: There are involved in tackling inflation it can cause an increase in unemployment or reduce economic growth

Government debt: Inflation erodes the value of government debt as the repayments are worth less than when the money was borrowed

Question 16

How does inflation effect workers

Answer 16

Higher wages: Workers demand higher wages to compensate for reduced purchasing power

Morale and productivity: If wages increase inflation, motivation and productivity may fall as workers dont receive the same benefit.

Question 17

What is hyperinflation?

Answer 17

A very high and typically accelerating inflation as it quickly erodes the real value of the local currency

Question 18

How can Demand side policies cause deflation?

Answer 18

Demand side deflation is caused by a fall in total aggregate demand in the economy being the sum of all expenditure in the economy as measured by real GDP if any one of the four components of rGDP decreases there is a decrease in the total demand and the general price level will fall

Question 19

When does Deflation occour?

Answer 19

When the percentage change in prices falls below 0%

Question 20

What are the consequences of Demand side deflation?

Answer 20

Unemployment - If there is a reduction in demand unemployment will rise fewer workers needed to produce fewer goods and services due to a decreased derived demand for labour.

Consumers lose confidence- with falling output and rising Unemployment, households loose confidence choosing to save instead to spend consumption fall rGDP reduces.

Debt- Debt is more burdensome as the value of any debt is worth more. Cost or borrowing increases as real intrest rates rise when the price level falls

Exports- Persistently falling prices can prove attractive to foreigners & the level of exports may increase (this helps offset some of the reduction in rGDP)

Question 21

What is supply side Deflation?

Answer 21

Supply side deflation is caused by an increase in the productive capacity of the economy
Increase in the quality/ quantity of the factors of production. Creates excess supply in the economy GPL fall National output increases

Question 22

What problems does inflation cause?

Answer 22

Inflation erodes the value of money/spending power, which increases the cost of living inflation may also be fluxuating which creates unconfidance. Inflation may reduce international benefits which worsens the balance of payments. Deflation may be caused by a decrease in AD which means that consumers delay purchases as a consequence, firms reduce output as profit may be falling.

Question 23

What are the consequences of Supply side deflation?

Answer 23

Unemployment-With a decrease in costs, the output of firms increases. More workers are required & so unemployment falls

Consumers gain confidence-With rising output & falling price levels, households become more confident & consumption increasing - increasing rGDP even more

Debt-Debt still feels more burdensome as the value of any debt is worth more

Firms gain confidence- Rising output & falling costs of production cause firms to gain confidence & increase investment, thereby increasing rGDP

Exports- Persistently falling prices boosts international competitiveness & exports increase

Question 24

What are some of the bad effects of deflation?

Answer 24

Output may fall if the deflation is due to lower aggregate demand, because firms will cut back their production. Reducing economic growth.

If there is a reduction in demand, unemployment may rise because fewer workers will be needed to produce fewer goods and services due to a decreased derived demand for labour

Question 25

What are some of the good effects of deflation?

Answer 25

If deflation is occurring due to lower cost of production or advances in technology (supply side deflation)/ this may increase national output and cause economic growth to occour

If domestic products have become more price competitive exports may increase as they are relatively cheaper and this will improve the balance of payments position.

Question 26

What are the conflicts with contractionary policies?

Answer 26

One conflict caused by contractionary policy is that reducing demand pull inflation also reduces output & employment

Question 27

Why are demand side policies effective?

Answer 27

Demand-side policies can very effective at dealing with deflation
Expansionary monetary policy tends to increase inequality in the distribution of income as the poor are usually unable to benefit from it (banks do not necessarily lend to the poorest households)

Question 28

What causes deflation?

Answer 28

Deflation caused by a fall in total demand (e.g. during a recession) is best addressed using expansionary demand-side policies