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ECON313 > Chapter 8 > Flashcards

Chapter 8 Flashcards

1
Q

Why are the prices of goods and services important in a market economy?

A

Because they reflect information on the supply and demand of products.

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2
Q

What will happen to the price of the product, If demand increases and supply remain unchanged?

A

The price will increase.

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3
Q

What will happen to the price of the product, if supply increases and demand stays the same?

A

The price will decline.

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4
Q

What do these changes in prices indicate?

A

What, when and for whom to produce. In other words they determine the efficient distribution of resources in a market economy.

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5
Q

What is inflation?

A

A continuous and considerable rise in prices in general.

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6
Q

What are the two points about inflation that have to be emphasized?

A
  • The increase in prices must be continuous.
  • Inflation only occurs when the general level of price is increasing.
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7
Q

What is the secondary effect of inflation?

A

The effect of the price increase of a good bringing about increases in other prices.

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8
Q

What are the 3 forms of inflation?

A
  • Moderate
  • Galloping
  • Hyperinflation
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9
Q

What is moderate inflation?

A

Inflation where prices rise slowly at single digit annual inflation rates.

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10
Q

What is galloping inflation?

A

Occurs when the inflation rate rises at double-digit rates per year.

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11
Q

What is hyperinflation?

A
  • The extreme form of inflation
  • Rate of inflation exceeds 50 percent per month.
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12
Q

What is deflation?

A
  • Opposite of inflation
  • Prices declining over time
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13
Q

When does deflation become a problem?

A

When the expectation of lower prices in the future results in consumers postponing consumption.

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14
Q

What is disinflation?

A

The process of declining rate of inflation over time.

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15
Q

What is stagflation?

A

High inflation accompanied by high unemployment.

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16
Q

What are three main measures of inflation?

A
  • Consumer price index (CPI)
  • Producer price index (PPI)
  • The implicit GDP deflator
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17
Q

What is the CPI?

A

-Most commonly used indicator of the general price level.
-Reflects the cost of a representative basket of consumer goods and services.
- In a chosen base year, the expenditure of the typical consumer on goods and services is weighted according to the amount spent on each item.
-When we say that the inflation rate is 10%, this means that prices are increasing at a rate of 10% per year.

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18
Q

How often is the CPI reported?

A

On a monthly basis by StasSA, since inflation is a continuous process.

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19
Q

Why is it important for the CPI to be revised regularly?

A

After a while, the weights may not be the true reflection of the amounts spent on the various goods and services because of quality changes, new products that are developed and other changes in the spending patterns.

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20
Q

What is the PPI?

A

-Also important price index but differs from CPI
-Associated with the cost of production
-Basket consists of capital & intermediate goods
-Measures change in wholesale prices, i.e. prices of production

21
Q

Why is the PPI less comprehensive than the CPI?

A

Because it does not include the prices of services.

22
Q

How often is the PPI measured?

A

Also on a monthly basis.

23
Q

How is the GDP deflator calculated?

A

By dividing the value of the nominal GDP by the value of the real GDP, and multiplying the quotient by 100 to obtain an index value.

24
Q

What does the GDP deflator include?

A

The price of all goods and services produced in a country, not only goods and services consumed.

25
Q

What is the major problem of using this index?

A

It is only made available on a quarterly basis, with figures becoming public two months after the end of each quarter.

26
Q

List the different types and causes of inflation

A
  • Inherent Inflation
  • Cost-push inflation
  • Demand-pull inflation
27
Q

How does inherent inflation take place?

A

It takes place because the general price level tends to continue to increase at the rate that it has reached in the past.

28
Q

Why does inherent inflation occur?

A
  • People expect price increases to reflect historic levels.
  • The expected rate of inflation is then taken into consideration in the conclusion of contracts, informal arrangements and wage negotiations, causing the inflation rate to come closer to the expected rate of change.
29
Q

What will the projections that the inflation rate will increase do to the central bank?

A

It will encourage the central bank’s monetary policy actions and can result in an increase in interest rates.

30
Q

What will the projections that the inflation rate will increase do to consumers?

A

It can result in higher demand and accelerating inflation.

31
Q

What triggers cost-push inflation?

A

The increase in the cost of production.

32
Q

List the sources of cost-push inflation.

A

-increased wages and salaries
-increased cost of imported capital and intermediate goods (oil)
-increased profit margins
-natural disasters
-decreased productivity

33
Q

Explain figure 8.1, a figure that depicts cost-push inflation.

A
  • The economy is in equilibrium at point Y0 and price P0.
  • An increase in any of the sources of cost-push inflation reduces aggregate supply and shift the supply curve to the left (AS0- AS1).
  • The aggregate demand curve (AD0) remains unchanged.
  • As a result of the shifting AS curve, prices increase.
  • This has to happen repeatedly for it to be inflationary.
34
Q

What triggers demand-pull inflation?

A

-Arises when total aggregate demand exceeds the output that an economy can produce at full employment.
-Described as too much money chasing too few goods and services.

35
Q

What causes this excess demand?

A

Increase in:
- Household consumption expenditure
- Government consumption expenditure
- Investments
- Exports
(C+G+I+X-Z)

36
Q

Explain figure 8.1, a figure that depicts demand-pull inflation.

A
  • The economy is at equilibrium at Yf and P0.
  • Yf also denotes full employment output (does not mean there is no unemployment in the economy) .
  • This implies that all resources are fully utilized and AS cannot increase and move to the right.
  • As AD increases, moves from AD0 to AD1, AS remains unchanged since the economy is at full employment equilibrium .
  • Yf remains constant but price levels increase.
  • It has to happen repeatedly for it to be inflationary.
37
Q

What do the costs of inflation depend on?

A

-severity of inflation
-period of time over which it occurs
- Whether it is anticipated or not

38
Q

List the costs of inflation.

A
  • Redistribution of income
  • Wage pressure where workers demand higher wages
  • Makes an economy less competitive
    -Undermines efficiency of pricing system
    -Undermine economic growth
    -Higher taxation – pushes workers into higher income brackets although the real value
    of their income is less
    -Additional costs
    -Taking away wealth from people who save to those who have debts
    -Benefits those who borrow at fixed interest rates
    -Hurts those who lend or save at fixed interest rates, particularly when the inflation is not anticipated
39
Q

What is the effect of the redistribution of income?

A

-The poor cannot protect themselves against inflation – remember store of value function of money?
-Problem for people like pensioners with fixed income

40
Q

How does inflation undermine the efficiency of the pricing system?

A

It becomes difficult to determine whether prices change as a result of changes in the demand of the product or just part of the general price increase.

41
Q

How does inflation lead to additional costs?

A
  • Certain expenditure rises with a sustained increase in prices
  • For example, sellers have to change the prices of goods on shelves and also in mail catalogues.
42
Q

What are the main factors contributing to inflation in South Africa?

A

-Structural inflation
-Exchange rates
-Labor market
-Administrative prices

43
Q

What is the structural inflation theory based on?

A

-On the premise that inflation triggers a process of price increases as labour, businesses and consumers try to maintain their real income.
-This feeds into the process of inflation.
- Interaction between underlying, initiating and propagating factors also initiates an inflationary process.
- A process of generally increasing prices can only occur if these factors are present.
- Rigidities in the economic structure of a country also feed sustained price increases and therefore the price level, even in aggregate supply and aggregate demand in the economy as a whole in equilibrium.

44
Q

What exactly are structural rigidities?

A

Factors such as supply deficiencies, resulting in cost-push inflation or demand stimulation resulting demand-pull inflation.

45
Q

What was the decline in inflation dependent on in South Africa?

A
  • International trade liberation
    -Smaller government budget deficits
  • Persistent sound monetary policy
  • Improvements in the overall competitiveness of the domestic economy.
46
Q

How do exchange rates affect inflation?

A

-Rand exchange rate has significant costs for the SA economy since the economy is an open one
-Weak currency makes imports more expensive, putting pressure on domestic prices.
-Feeds the process of inflation
-Considerable depreciation in the Rand during the 1980s fueled the inflationary process in SA inflation
-However, the adoption of the inflation targeting regime has resulted in a relatively stable Rand, even though exchange rates still feeds on the inflation rate.

47
Q

What effects does the Labour Market conditions have on inflation?

A

-Can affect inflation from a cost of production perspective, generating cost-push inflation.
- By factors such as skills shortage and structural unemployment.
-Rigid labour legislation
-Active labour unionization
-Intervention of government in the labour market or bargaining power of trade unions often result in increased costs of production, especially when the wage increases are not accompanied by increased productivity.
-This has been a massive problem in South Africa for years.

48
Q

What are administrative prices?

A
  • Determined or influenced, directly or indirectly, by the government, government agencies or institutions and referred to as regulated administered prices.
  • Set by producers or suppliers where they are referred to as non-regulated administered prices.
    -Regulated: Electricity tariffs, TV licenses, water & fuel tariffs etc.
    Unregulated: University and college fees.
49
Q

How does the adjustment of administrative prices contribute to inflation?

A

-Most of these costs are input costs, which may feed the inflationary process through the production cost side – triggering cost-push inflation
-Producers then pass these cost increases to consumers

ECON313 (6 decks)

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