Inflation

Question 1

Inflation Denifinition

Answer 1

• persistent increase of prices in an economy in a year

- rate of money loses value

Question 2

Consumer Price Index (CPI)

Answer 2

Sum of weighted Index / Sum of weight

Question 3

Rate of Inflation

Answer 3

(Current year CPI - Base year CPI) / Base year CPI * 100%

Question 4

Causes of Inflation

Answer 4

Demand Pull Inflation

• AD shifts to the right
• Greater pressure on existing factors of production to produce more output

Cost Push Inflation

• SRAS shifts to the right
• Price of factors of production increase

Money Supply

• Fisher’s Theory Quantity of Money MV = PT
• Larger money supply is spread over the same quantity of goods

Question 5

Costs of Inflation

Answer 5

Purchasing Power decreases
- money loses value

Menu costs

• Physical resources expanded on making price adjustments
• Firms need to calculate & issue new prices

International Competitiveness decreases

• X is relatively expensive
• M is relatively cheap

Question 6

Benefits of Inflation

Answer 6

Stimulate Output

• Increase profit
• Firms feel positive
• Prevent unemployment

Stimulate Consumption
- reduce debt burden

Question 7

Evaluation

Answer 7

Depends on rate of rising
HARMFUL (High and accelerating)
- causes uncertainty
- discourage investment
- workers want higher wage which leads to higher cost of production
NOT HARMFUL (low and stable)
- easy to plan

Comparison with other countries
HARMFUL(higher than other countries)
- Worsen CAD
NOT HARMFUL (lower than other countries)
- More price competitive

Anticipated vs unanticipated
HARMFUL (unanticipated)
Causes redistribution of income from lenders to borrowers
NOT HARMFUL (anticipated)
Firms can adjust to prices, gov can adjust tax rate, banks can adjust nominal interest rate