Econiomics 2.5.3 Flashcards
What is inflation
“The rate of change in the average price level over time.”
What are the two main measuring factors for inflation
The Consumer Prices Index (CPI)
The Retail Prices Index (RPI)
How does the national office of statistics measure inflation
The Office of National Statistics (ONS) compile the CPI and RPI
Both measures are based upon a basket of goods and services which is designed to represent typical purchases of consumers throughout the UK
There are around 700 items in the basket of goods and services
Different items are weighted according to their relative importance in terms of how much their price changes impact upon consumers
For example, petrol is given a high weighting given that it forms a large part of individuals disposable income and there are few direct substitutes
What is nominal value
this is expressed in monetary terms
it doesnt take into accoubnt inflation
what is real value
it takes inhto account inflation
how is real national output measured
real national output = nominal national output/Average price level
How is short run economic output measured
annual percentage change in real national output, real national income or real gdp
What are the three primary causes of inflation
Demand-Pull
Cost-Push
Growth of the money supply
How does demand pull inflation effect
Demand-pull inflation is caused by excessive demand in the economy for goods and services
there is too much money chasing too few goods and services
How is demand pull inflation caused
Reduced taxation
Increases disposable income
Lower interest rates
Makes borrowing more attractive and saving less rewarding
A general rise in consumer spending
Perhaps from higher incomes and consumer confidence
Improved availability of credit
Banks/Building Societies widen the availability of credit or make it more affordable
A weak exchange rate
Will boost export growth
Fast growth in other countries
May increase demand for UK exports
General rise in confidence / expectations of future growth
May feed through to higher consumer spending and investment
Certainty
Links to confidence and assists consumers and firms in their spending and investment decisions
(demand increasees on the diagram)
How does cost push effect
This occurs when firms respond to rising costs of production by increasing prices
Firms will typically do this to protect profit margins
That said, firms may be able to absorb some increases in their costs of production, but they will not be able to do this indefinitely, and so pass costs onto the consumer in the form of higher prices
What causes cost push inflation
Wage increases
For many firms, wages is their largest single cost of production
It is likely that if prices are rising, workers will demand higher wages in order to maintain their ‘real’ incomes
If these higher wage costs are reflected in higher prices, then workers will continue to demand higher wages, leading to a wage-price spiral
Higher raw material costs
As primary raw materials become more scarce and in even greater demand, raw materials and associated components may rise in price
Higher taxes
The government may impose higher taxes on firms; for example, corporation tax, national insurance, or taxes on waste disposal
Higher import prices
A weaker exchange rate or rising prices abroad mean that imported components feed through to higher costs of production
Natural disasters
May temporarily or permanently reduce the supply of raw materials or disrupt the supply chain, adding to a firms costs
reduces sras
What is deflation
Deflation is a decrease in the general price level
What causes deflation
Deflation tends to occur during periods of very low, or stagnant growth
As prices are falling, consumers tend to delay purchasing decisions because they think prices will fall in future
As a result, consumption slows significantly
What is disinflation
In other words, it is a fall in the rate of inflation
Therefore, prices are still rising but at a slower rate
the rate is still rising -just slower
what does inflation do to firms
High inflation will lead to consumers purchasing goods and services today before prices rise further in the future thus increasing demand in the short run
Firms will pass costs on to the consumer which will further fuel higher prices and increases in inflation
Workers will bargain to increase their wages. Collective bargaining will take place with the union negotiating with employers to improve wage rates
This further increases costs for firms and there may be a wage-price spiral as higher wages lead to higher costs for firms, leading to calls for higher wages etc.
Loss of international competitiveness arises as higher prices make UK products less attractive leading to a fall in demand for UK goods and services
This is particularly the case if these products are price elastic making it easier for importers to look elsewhere as there are likely to be more substitutes
What is the effect of inflation to consumers
If wages and earnings remain constant, then as prices rise, consumers are worse off in real terms, as their real income will buy less goods and services than previously
Therefore it is said that inflation erodes the value of money
At the same time the return of savers will be less in real terms as inflation eats into the value of their savings
However, borrowers are better off as they will be paying back less in real terms e.g. high inflation rates might be greater than the interest that they pay back
