Inflation Flashcards
what is inflation?
a sustained rise in the cost of living or the general price level leading to a fall in the purchasing power of money.
what is deflation?
a decline in the general price level in an economy signified by annual inflation rates below 0% (negative). it is a sign of stagnation in an economy.
what is disinflation?
a fall in the rate of inflation, prices rise more slowly than they have done in the past e.g. from 5% to 2%
what is hyperinflation?
a period of very high rates of inflation, usually leading to a loss of confidence in an economy’s currency.
what is the process of calculating the rate of inflation in the UK using the Consumer Prices Index (CPI)?
1) The Office for National Statistics (ONS) collects prices on 710 goods and services from 20,000 shops in 141 locations and online sites and the prices are updated every month.
2) a ‘consumer basket’ of most popular goods/services is formed with average prices attached- represents spending of average family.
3) It takes into account how much is spent on each item so they are weighted i.e. we spend more on petrol than on postage stamps so an increase in petrol will have a bigger impact on the overall rate of inflation
what are limitations of the CPI?
● It is impossible for the figure to take into account every single good that is sold in the country and so therefore the CPI is not totally representative . Similarly, different households spend different amounts on each good and so therefore the CPI only measures an average rate of inflation, and is not totally representative.
● Moreover, it does not include the price of housing and so, since this has tended to rise more than the price of other goods, the data may be lower than it should be.
● Since the figure is more recent than RPI, it is difficult to make comparisons with historical data. It was only used since 1996 with estimates going back to 1988 which means that levels of inflation using CPI can only be accurately compared back to then.
what is the Retail Price Index (RPI) as an alternative measure of inflation?
very similar to CPI. RPI includes housing costs such as mortgage and interest payments and council tax, whereas CPI does not.
CPI takes into account the fact that when prices rise people will switch to product that has gone up by less. Therefore, the CPI is generally lower than the RPI.
RPI excludes the top 4% of income earners and low income pensioners as they are not ‘average’ households whilst CPI covers all households and all incomes.
what are the causes of inflation?
demand pull
cost push
growth of money supply
what is demand-pull inflation?
Prices in a market are determined by demand and supply and a shift in either will
cause price to change. Inflation can therefore be caused by an increase in aggregate
demand (AD), total demand for goods and services in the economy. If any factor which increases AD was to increase , then inflation would increase
what is cost-push inflation?
Cost push inflation is inflation caused by an increase in prices of inputs like labour, raw material, etc. The increased price of the factors of production leads to a decreased supply of these goods. While the demand remains constant, the prices of commodities increase causing a rise in the overall price level.
When businesses find their costs have risen, they will put up prices to maintain their profit margins.
how does growth of money supply cause inflation?
too much money in the economy. If people have access to money they will want to spend it but if there is no increase in the amount of goods and services supplied, then prices will have to rise.
The government can also increase the amount of money that they print and decisions to increase government borrowing can also increase the money supply.
what effects does inflation have on consumers?
- If people’s incomes do not rise with inflation then they will have less to spend , which could cause a fall in living standards.
- Those who are in debt will be able to pay it off at a price which is of cheaper value, but those who are owed money lose because the money they get back is of cheaper value. Consumers who have saved will lose out as their money is worth less.
- Inflation has psychological effects on consumers: because prices are rising, they may feel less well-off, even if their income is rising in line with inflation, and so this may cause them to decrease their spending.
what effects does inflation have on firms?
- If inflation in Britain is higher than other countries, British goods will be more expensive. They will become less competitive and make them more difficult to export. This will also affect the balance of payments.
- firms will have to calculate new prices then
change their menus, labelling etc. and this can be expensive. - In general, inflation/deflation/disinflation is difficult to predict and so this means that
firms cannot plan for the future.
what effects does deflation have on firms?
Deflation isn’t good as it encourages people to postpone their purchases as they wait for the price to fall further. People will be more likely to save as the value of their money will rise in the future and they will be prevented from borrowing as deflation means the real value of their debt increases. This can lead to a fall in demand for goods, leading to a fall in firms’ profit, and in business confidence which can lead to a long term reluctance to invest.
what effects does inflation have on government?
If the government fails to change excise taxes (taxes at a set amount e.g. £1) in line with inflation then real government revenue will fall. However, if they fail to change personal income tax allowances (the amount a worker can earn tax free) then real government income will increase and taxpayers will have less money
