Ch 9: Inflation Flashcards
Define inflation
the persistent and appreciable rise in the general level of prices
What is Australia’s goal for price stability and what is it currently?
to maintain inflation between 2-3% current inflation rate: 1.5%
How is inflation measured and describe the weight system?
> the most familiar method is the Consumer Price index which summarises the overall change in the prices of a large number of goods and services
- g & s are classified into - 11 major groups, 33 subgroups and 87 classes of expenditure
- the ABS attaches a weight to each commodity (and group) in order to reflect its importance in the pattern of expenditure by an ‘average household’
- weight = positive statement
- higher weight: housing, food, non-alcholic drinks
- lower weight: clothing, education
How is the annual rate of inflation and price index calculated?
price index = price x weight
rate = (Y2 Price Index - Y1 Price Index)/ Y1 Price Index
What is demand pull inflation and what is an example?
> rising prices caused by an excessive level of aggregate expenditure compared to the resources available at the time.
High levels of aggregate demand are indicated by:
- high levels of durable consumption spending
- excess demand for labour in some sectors, forcing wages up and thus prices
- excess money supply - rate of growth of money supply is greater than rate of growth of real output
i.e. 2004-2006 building boom: high demand created a relative shortage of skilled building tradespersons so contract prices rose sharply
What is cost push inflation?
> rising production costs are passed on to consumers, who then have to pay higher prices for final g&s. It affects aggregate supply and the costs reflect the prices for productive inputs.
Periods of cost push inflation can be attributed to:
- wages increasing more than productivity
- when the price of imports (resources/capital) rises (perhaps as a result of depreciation of the domestive currency)
- government charges and taxes rise (i.e. GST and carbon tax)
- when oil prices rise, as oil is a significant production and distribution cost
i.e. rapid increase of oil prices rom $25/barrel in 2003 to $147 in July 2008
What are the output effects of inflation?
> inflation impacts on level of output, income and employment
- real income falls - if prices rise faster than income
- economic efficiency and the level of production in the economy - inflation directs resources away from productive activities to speculative activities due to uncertainty to productive decisions
- promotes uncertainty - savings and investment discouraged (potential economic growth reduced), investment decisions w capital expenditure more risky -> affects expenditure and income, reduces output and employment opportunities
- capital-for-labour substitution - occurs when wages rise faster than productivity i.e. 2007-2012 mining boom, companies employed remote-controlled trucks
- lack of confidence in money as a store of value - consumers purchase assets which are likely to appreciate in value, speculative activity can have a negative impact on the potential output of the economy if speculation becomes an easier way to create wealth than innovation and risk-taking in real markets
- real interest rates - if inflation rises, this places upward pressure on the nominal and real interest rate (bc premium for risk rises)
- international competitiveness - country is at a disadvantage if its domestic inflation is greater than its competitors
- economic collapse - due to hyperinflation (when above 30%), happens if there is a diversion of effort towards hoarding or non-productive activity
What are the redistribution effects of inflation?
> inflation affects the distribution of income and wealth
- the burden of inflation does not fall evenly on all sectors of the community
- those groups who are able to anticipate may be able to benefit from expected price increases also sectors w more market power seem more capable of maintaining their real incomes i.e. aggressive trade unions
- living standards of low income earners and recipients of transfer incomes (pensions) will fall unless these payements are indexed to the price index
- creditors lose - because the value of the meny they lend loses value
- debtors gain - because they can build up their assets on borrowed money, knowing that the real value of their repayments will fall over time
- ‘pay as you go’ taxpayers will suffer bracket creep as income levels rise to levels where they are liable for higher marginal rates of taxation
- govt. benefit for greater revenue
- effects depend on how well price increases were anticipated by the community
What does demand pull inflation look like?
What does cost push inflation look like?
Define aggregate demand v aggregate supply:
aggregate demand: the total amount of spending in the economy from all the different sectors
aggregate supply: the relationship between the total output of g&s that producers are willing to produc and the general price level
