Book 8: Price Stability Flashcards
Define inflation
Sustained increased in GPL of an economy
What are the types of Inflation
- Demand-pull
- Cost-push
What is the cause of demand-pull inflation ?
Continued increase in AD
Assuming the economy is near or at full potential
How does increased in AD lead to inflation ?
unplanned fall inventories , profit motivated firms respond by increasing production by hiring more FOP
operate closer to full employment, firms use resources that are less and less suitable for their production. With less efficient factor combination, firms need increasing larger amount of FOP to produce additional units of output
Firms only willing and able to produce additional units of output if sold and higher prices
What is the causeof cost-push inflation ?
Continued increase in UCOP which are not caused by increase in AD
- increase price of imported inputs
- depreciation of home currency
How does increase in UCOP lead to cost-push inflation ?
UCOP — fall in AS
Firms are only willing and able to produce at the same output level if they receive higher prices, GPL rises
Firms pass on higher unit cost to consumers as higher prices
If the rise in UCOP persists, AS continues to fall while horizontal AS continues to shift upwards and GPL continues to rise
What are the types of deflation ?
- Demand-side
- Supply-side
Cause of DD side deflation
Describe DD side deflation
Fall in AD
Unplanned rises in inventories
Increase unemployment
Firm more able to hire FOP more suitable fir their production
More efficient factor combination
UCOP
While. Firms lowers outputs, GPL falls as well
Cause of SS side deflation
Fall in AD
- decrease in foreign income levels
- credit crunch leading to C fall and I fall
- fall in price of imported inputs
Describe SS side deflation
Decrease UCOP
Firms now willing to offer more output for sale at same prices.
AS rises, AS curve shifts…
The rise in AS leads to downward pressure on GPL .. as firms pass on the cost savings to consumers as lower prices.
Impacts of inflation on HH
If HH nominal income rises faster than GPL: higher SOL
- rise in real income
- HH more pp, spend more on g&s that cater to their needs and wants
If HH nominal income rises slower than GPL: lower SOL
- fall in real income
- HH less pp, spend less on g&s that cater to their needs and wants
Impact on firms
Demand-pull: higher profits
- factor input proces tend to be unchanged due to long term contracts
- increase in prices of g&s rises faster than the unit cost of production
Cost-push: lower profits
- firms try to pass on higher unit costs onto consumers as higher prices
- cannot fully pass on, absorb part of increase in unit cost
Impact on EG and unemployment
Prolonged deflation: negative SG
- consumer anticipate that prices continue to fall
- cut back on consumption to buy goods and cheaper prices in the future
- C fall, AD fall, downward multiplier
- multiplied fall in rGDP
Prolonged delaflatin: unemployment
(Same as above)
-larger output gap
Impact on BOT
