6.1 – Price Inflation Flashcards
What is inflation?
Inflation is the general and sustained rise in the level of prices of goods and services in an economy
How is inflation caused?
Demand-pull inflation: Inflation caused by an increase in aggregate demand. Also defined as the increase in price due to aggregate demand exceeding aggregate supply.
Cost-push inflation: Inflation caused by an increase in cost of production in the economy.
What is agreed as the key reason for inflation?
A rise in money supply in contrast with output
What are the Consequences of Inflation:
Lower purchasing power
Exports are less internationally competitive
‘Inflation causing inflation‘: during inflation, the cost of living in the economy rises as you have to pay more for goods and services. This might cause cost of production to rise, causing cost-push inflation.
Fixed income groups and lenders lose
How is inflation measured?
Measured using an consumer price index (CPI). A basket of goods is assembled. It consists of the typically purchased products of a family and is given a value of 100. This 100 is called the Base Year, and is used in this formula: Percentage Price Increase * 100. It is accumulated, and so it rises each year and the base year changes.
What is Deflation?
The general fall in the price level.
What are the Causes of Deflation?
Aggregate supply exceeding aggregate demand: a shift in the supply curve to the right will cause an extension in the demand, causing a fall in the price.
Labour productivity has risen: higher output will make for lower average costs, which could reflect as lower prices.
Technological advance has reduced cost of production, pulling down cost-push inflation.
Demand has fallen in the economy: this could be due to a number of reasons: higher direct taxes, higher interest rates etc.
What are the Consequences of Deflation?
Lower prices could demotivate producer and they may reduce production, resulting in unemployment.
As demand falls and prices fall, investors will be discouraged to invest, lowering the output/GDP.
Deflation can cause recession as demand and prices continue to fall and firms are forced to close down as enough profits are not being made.
Tax revenue for the government will fall as economic activity and incomes falls. They might be forced to borrow money to finance public expenditure.
