Inflation Flashcards
Define inflation
Inflation refers to how much prices go up each year on average. The Governments target for inflation is 2% + or - 1% (1-3%)
The Measurement of inflation
Inflation is measured through the construction of index numbers, which are based on 2 main principles:
1) A base year is chosen and the index is given a base of 100
2) To work out inflation, the prices of all the goods that people buy are weighted to take into account the relative importance of those items of expenditure to the average family.
Inflation =
[(Sum of price change good A * Weight good A) + (Sum of price change good B * WGB) + … ] / The sum of the weights
Calculating inflation using index numbers
% change = [(Change in index) / (Original value of the index that year)] x 100
The government has 2 main measures of inflation. These are?
1) Consumers Price Index - Usually referred to as the CPI. That measures change in the average prices of most of the goods and services a typical family buys. In December 2021 it was around 5.1% - way above the wanted 2%
2) Retail prices Index (RPI) including changes in the prices of goods most people buy + takes into account changes in people housing costs such as mortgage payments, rent and house prices.
Which is higher - CPI or RPI?
Because house prices tend to go up much quicker than other goods, the RPI will tend to be higher
Who might the CPI and RPI not be very accurate for?
Because the CPI and RPI only measure what is happening to inflation for the average family, they tend to be far less accurate measure of inflation for the very rich and the very poor. This is because these people tend to spend a different proportion of their income on different types of goods.
The effects of inflation
Inflation will tend to have a number of negative effects on the economy, particularly if it is increasing quickly . These include:
1) Creates more uncertainty - More difficult for businesses to plan ahead if they don’t know whats going to happen in the future - less investment = fall in AD
2) If our inflation keeps going up, it will make our businesses less internationally competitive - Businesses will be pushed out of the market and we will tend to buy more imports
3) When you have got higher inflation, it will add to certain costs for consumers and businesses, such as menu costs (The costs to businesses if they have to keep changing their prices), and hoe leather costs (The time wasted looking for better bargains which has an opportunity cost.
4) Some people will tend to benefit from inflation and some will lose out. E.g. Savers lose out (old people), People in debt will benefit (Young people)
Causes of inflation
1) Demand pull theories of inflation. This is where inflation is caused because of too much spending in the economy.
