8.3 Inflation and deflation Flashcards
What is inflation?
The rate of change in the average price level over time
Why does inflation matter?
If wages and earnings remain constant, then as prices rise, consumers are worse off in real terms, as their disposable income will buy less goods and services than previously
What are the two principle measures of inflation?
The consumer price index (CPI)
The retail price index (RPI)
What is the basket of goods and services?
Designed to represent typical purchases of consumers throughout the UK
Different items are weighted according to their relative importance in terms of how much their price changes impact upon consumers
What are the two primary causes of inflation?
Demand-pull inflation
Cost-push inflation
What causes demand-pull inflation?
Demand-pull inflation is caused by excessive demand in the economy for goods and services
What are examples of when demand-pull inflation would occur? (8)
Reduced taxation Lower interest rates Rise in consumer spending Improved avalilability of credit A weak exchange rate Fast growth in other countries General rise in confidence Certainty
What shift would demand-pull inflation cause on an AD-AS diagram?
Increase in AD
When does cost-push inflation occur?
Occurs when firms respond to rising costs of production by increasing prices
What are examples of when cost-push inflation would occur? (5)
Wage increases Higher raw material costs Higher taxes Higher import prices Natural disasters
What shift would cost-push inflation cause on an AD-AS diagram?
A decrease in SRAS
What is deflation?
A decrease in the general price level
What is disinflation?
When the average price level doesn’t fall but increases at a slower rate
What are the problems with deflation? (5)
Deflation tends to occur during periods of very low or stagnant growth
Despite the fact that the value of money would be rising, deflation generally indicates that demand is very low or suppressed
As prices are falling consumers tend to delay purchasing decisions because they think prices will fall in future
As a result consumption slows significantly
Which is likely to mean that firms will lose the confidence to invest, thus harming aggregate demand still further
