Inflation Flashcards
Define inflation
This refers to how much prices go up each year on average. The governments target for inflation is 2% (+ or - 1%)
What are the 2 main principles for the measurement of inflation?
1) A base is chosen and the index is given a base value of 100. Price changes are then subsequently compared to that value.
2) To work out inflation, the prices of all the goods that people buy are weighted go take into account the relative importance of these items of expenditure to the average family.
What is a weight in relation to inflation?
How important a variable is in inflation, therefore impacting how much they influence inflation.
Formula for inflation (+Weight)
inflation = [(Price change good A x Weight good A) + Price change good B x Weight good B) + …] / [The sum of all the weights]
Inflation and % change
Inflation will be equal to the % change in the value of the index each year
what are the 2 government measurements of inflation?
1) CPI - Consumer price index - Measures changes in the average prices of most of the goods and services a typical family buys.
2) RPI - Retail price index - Includes CPI and changes in peoples housing costs, such as rent, interest rates for mortgage payments and house prices. As these typically rise faster than normal goods, the RPI is typically higher.
Name one drawback of CPI/RPI
It may exclude representation for the very rich and very poor, as they have different costs from the typical family.
For example, the very rich may spend more on luxury goods, and the very poor may spend a higher % of their income on food and electric.
Name the 4 effects of inflation
1 - Creates more uncertainty
2 - Makes our businesses less internationally competitive
3 - Increases certain costs for consumers and businesses
4 - Some people will tend to benefit (People in debt e.g. student loans) and some will lose out (Savers e.g. older people).
Why, if inflation keeps going up, will our businesses be less internationally competitive?
Because imports will become cheaper. and domestic consumers may choose to import goods instead, having 2 effects on our economy:
1) Businesses will be pushed out of the market
2) We will tend to buy more imports, worsening the trade deficit.
What are 2 costs that increase for consumers/businesses as a result of inflation?
1) Menu Costs - Referring to the costs to businesses if they have to keep changing their prices e.g. physical copies of menus and catalogs. (Not so much now as everything is digital)
2) Shoe Leather Costs - This is an argument that if prices keep going up, businesses will spend more time looking for bargains, this time has an opportunity cost.
Why will savers ‘lose out’ when inflation is increasing?
Because their savings are worth less - things are more expensive
Why will people in debt ‘benefit’ from inflation?
Because the money you pay back is worth less.
What are the 2 causes of inflation?
1 - Demand-pull theories of inflation
2 - Cost-push inflation
Explain demand-pull theories of inflation
1
Explain cost-push inflation
This is where businesses are having to put up their prices because their costs are increasing. If they don’t do this, their profit will go down.
Prices may be increasing because of increasing prices in: Wages, energy costs, raw materials, taxes. OR a fall in the exchange rate, as everything imported is more expensive.
