Chapter 9

Question 1

Inflation

Answer 1

Inflation is a persistent and appreciable rise in the general level of prices. Describes noticeable price increases that occur over time and across a range of goods.

Question 2

Measurement of Inflation

Answer 2

Consumer Price Index (CPI) – an index number that records changes in the general level of prices

Question 3

Headline Inflation

Answer 3

Inflation rate including all items in the CPI (generally what is reported in the media); is a broad measure of changes in the cost of purchases made by households in capital cities

Question 4

Underlying Inflation

Answer 4

Inflation rate excluding volatile items from the CPI such as fruit and vegetables and the retail price of petrol. This is a more accurate measure of inflation as movements in some groups are influenced by short term factors such as agricultural commodities (when things are out of season) and economic policies – falling interest rates, taxes on certain goods etc.

Question 5

Limitations of CPI

Answer 5

1. Only reports price movements in metropolitan areas and families
2. Not regarded as a true cost-of-living index
3. Cannot account for changes in the quality of goods over time and is likely to overstate price increases
4. Doesn’t consider all goods

Question 6

Demand pull inflation

Answer 6

Demand pull inflation is a type of inflation when high levels of demand are caused by high levels of aggregate expenditure. This can occur when there is excess demand for the resources available at a time.

Question 7

High levels of aggregate demand are indicated by:

Answer 7

High levels of spending on construction and consumer durables
Excess demand for labour in some sectors of the economy
Excess money supply

Question 8

Cost pull inflation

Answer 8

Cost push inflation occurs when rising production costs are passed on to consumers, who then pay higher for final goods and services.

Question 9

Significant productive inputs include

Answer 9

Wages increase faster than worker productivity
Prices of imports rise
Oil prices rise

Question 10

Consequences of inflation

Answer 10

The effects of inflation can be categorised into two areas – level of output, income and employment and secondly the distribution of income and wealth in the economy.

Question 11

Output effects

Answer 11

Real incomes decrease
Economic efficiency decrease
Uncertainty
Lack of confidence

Question 12

Redistribution Effects:

Answer 12

Values of assets rise, holders of assets more wealthy
People on fixed wages or pensions lose out as value of money decreases
Creditors paid back with inflated dollars, not worth as much
Pushes people into higher tax brackets so they must pay higher taxes whilst purchasing power decreases

Question 13

Groups that gain with high inflation:

Answer 13

• Holders of assets
• The government
• Debtors

Question 14

Groups that lose with high inflation:

Answer 14

• People on fixed wages or pensions
• Creditors
• Taxpayers

Question 15

What can cause prices to rise?

Answer 15

natural disasters
increase in price of utilities
increase in wages paid
increase in price of imports

Question 16

Costs of inflation

Answer 16

reduced international competitiveness
increased uncertainty -> reduce confidence -> less investment and consumption

Question 17

hyperinflation

Answer 17

A period of very high rates of inflation (>30%), usually leading to a loss of confidence in an economy’s currency

Question 18

Why not 0% target rate?

Answer 18

some inflation is necessary as it encourages spending
With 0% or negative (deflation) - people may decide to purchase, knowing that prices
will fall and goods and services become cheaper

Question 19

benefits low inflation

Answer 19

healthy economy
price levels balance levels of supply demand
encourage productive factors like labour (wage prices) and enterprise

Question 20

cpi measures

Answer 20

quarterly changes in the prices of goods and services purchased by a typical household in metropolitan areas

Question 21

the cpi refers to a basket of goods and services that account for a high proportion of household spending

Answer 21

it is a survey of the prices of a wide range of goods and services that households buy, each item and group is weighted according to its relative importance in household purchasing patterns

Question 22

headline definition

Answer 22

Headline inflation measures the total inflation within an economy, including all goods and services.

Question 23

headline components

Answer 23

It includes volatile items such as food and energy prices, which can fluctuate widely due to factors like weather, geopolitical events, and market conditions.

Question 24

headline measurement

Answer 24

This is often the figure reported in news headlines and used in public discussions. It reflects the actual cost changes experienced by consumers and businesses.

Question 25

underlying definition

Answer 25

Underlying inflation, also known as core inflation, excludes certain volatile items to provide a clearer view of the long-term inflation trend.

Question 26

underlying components

Answer 26

Typically, core inflation excludes food and energy prices because these items can be highly volatile and can distort the overall inflation trend.

Question 27

underlying measurement

Answer 27

By focusing on the more stable components of the Consumer Price Index (CPI), core inflation provides a better measure of the underlying, persistent inflationary pressures in the economy.

Question 28

trimmed mean inflation

Answer 28

The top 15% and the bottom 15% of all price movements are “trimmed away” and removed from the inflation calculation. This removes the impact of the smallest and largest price changes

Question 29

weighted median inflation

Answer 29

The inflation rate is calculated based on the price change of the item that is at the middle of all of the price changes in the CPI basket.