government aims- inflation Flashcards
what are the governments macroeconomic objectives
A low and stable rate of inflation
A high level of employment
A sustainable rate of economic growth
A balance in trade over the long term
what is the definition of inflation
Inflation is defined as a period of generally rising prices.
what is the definition of the rate of inflation
The rate of inflation is the percentage increase in the general level of prices over a period of time (usually a year).
how does the government measure inflation
Retail Price Index (RPI)
RPIX - RPI without mortgage interest payments
Consumer Price Index (CPI) - RPI without housing costs and Council Tax.
how is the consumer price index calculated
1) A starting point or base year is chosen from which price changes are measured. All items are given a base index of 100.
2) Spending patterns are used to identify a basket of goods and services bought by typical households in the UK.
3) Each item in the basket is weighted according the amount of spending on it.
what does a fall in the rate of inflation mean
a fall in the rate of inflation does not mean a fall in prices. It means that prices are still rising but by a smaller percentage (at a lower rate)
what are harmful effects of inflation for an individual
Workers can lose their jobs if inflation in the UK makes goods and services produced here more expensive compared to other countries. Demand for these goods would fall, so less workers would be required to make them.
Inflation reduces the real income of those whose incomes are fixed or which do not rise as fast as the rate of inflation. Their standard of living falls. This can include those on state pensions, unemployment benefit or members of trade unions with little collective bargaining power.
It reduces the value of money. More money is necessary to buy the same amount of goods and services.
It reduces the real value of interest rates. If inflation is 4% and interest rates 5% then savings are only earning 1% in real terms. The real interest rate is 1%. This may discourage savers but encourage borrowing as in real terms the cost of borrowing is decreased.
what are harmful effects of inflation for a firm
UK firms will be less competitive with foreign competition both here and abroad which can lead to falling sales and profits which, in turn, can reduce investment.
Firms’ costs of production rise, e.g. raw materials, so firms are less profitable.
Higher prices of products may result in a fall in sales which make firms less profitable.
It increases uncertainty about future costs and prices. Firms may cancel proposed expansion plans if they do not know what it is going to cost them.
what are harmful effects of inflation for the economy
The balance of payments may deteriorate. Inflation makes our goods and services dearer and so less competitive. This will encourage UK consumers to buy more imports and our exports will be less price-competitive abroad.
Fewer exports and more imports lead to rising unemployment, placing a bigger strain on public spending as more people require state benefits and fewer are contributing through income tax.
As investment is discouraged, it can only have an adverse effect on economic growth in the UK. Firms won’t replace plant or fund expansion of premises.
Inflation can cause further inflation! Workers ask for wage increases to maintain their real income and firms pass this on as higher prices. This is called a wage-price spiral.
The gap between rich and poor widens as those on fixed incomes face falls in their real incomes. Private pensions do not necessarily increase with inflation. It is also possible that benefits and state pensions will fall behind price rises.
what are the positive aspects of inflation
borrowers gain because real interest rates are lower
some firms will increase their income from sales as some consumers will not be put off by higher prices
the government will take in more tax revenue from higher prices, i.e. VAT, and higher wages, i.e. income tax.
what are the 3 causes of inflation
demand pull inflation
cost push inflation
wage price spiral
what is demand pull inflation
This occurs when prices rise because total spending in the economy (aggregate demand) is greater than the output of the economy at that time. Output cannot increase in the short term and this excess demand by consumers pulls prices upwards.
what is cost push inflation
If costs of production increase faster than productivity then unit costs increase. Producers, in order to maintain profit levels, will pass this on to the consumer in the form of higher prices.
what is a benefit of using the CPI
The CPI is closer to the method used in other EU countries and so makes comparison of inflation rates more meaningful.
