Inflation Flashcards
What is Inflation
A sustained increase in the average price level over a given period of time
Define Disinflation
A sustained decrease in the rate of inflation over a given period of time
Define Deflation
A sustained decrease in the average price level over a given period of time
Does a fall in inflation = a fall in prices
No
Only when there is deflation does the general price level fall
What is the CPI
A price index that that measures the average price level of the basket of goods for a typical household. It is measured through the family expenditure survey where weights are attached in each item dependent on importance
Limitations of the CPI
Only representative of the average household
Doesn’t take into account improvements in quality + technology
Basket of goods change over time
Spending Patterns differ
Regional Differences in cost of living
Not Much Historical Data
Does Not Include Price of Houses - Risen more than price of other goods
What is RPI
Measures CPI + Living Costs (National Income, Mortgage Payments, Rent)
How can CPI be used to measure inflation
Changes in price level can be used to calculate inflation from different years through a base year of prices being chosen.
Inflation Effects on Consumers
Less to spend if income does not rise with inflation
Low inflation = better if in debt, worse if you’re lending
Inflation Effects on Firms
Harder to export - inflation
Hard to plan
Consumers postpone orders - deflation
Inflation Effect on Government
Fail to change excise tax in line with inflation - lost revenue
Fail to change personal income tax allowances - tax payers have less money
Inflation Effect on Workers
Deflation = Job Losses
Wage Increase not in line with Inflation - Worse off + decreased living standards
Equation of Inflation using CPI
Number in Period / Number in Base Period x 100 = % Change in Inflation
How does inflation redistribute income
Away from certain groups in the economy and towards other groups
When does redistribution arise
Situations where certain groups lose some purchasing power and become worse off and vice versa
Groups that lose from inflation
People who receive fixed income or wages
People who receive income or wages that increase slower than the rate of inflation
Holders of cash
Savers
Lenders/Creditors
Groups that gain from inflation
Borrowers/Debtors
Payers of fixed income or wages
Payers of income or wages that increase less rapidly than the rate of inflation
What is the money illusion
Some people feel better off when their nominal income increases - even though the price level may increase at the same rate or even faster
What is demand pull inflation
Excess demand in the economy which leads to the price level rising
Situations leading to demand pull inflation occuring
Low interest rates
High consumer confidence
Large increase in investment
Large Government spending increase or lower taxes
High demand for exports
Growth of the money supply
What is cost push inflation
Rising costs
Situations where cost push inflation occurs
Wages and salaries rise
Imports can rise
Higher prices
Raise in indirect tax rates or reduce subsidies
What do firms try to do with cost push inflation and potential drawbacks to this method
Pass the burden to customers
Competition in market may make this difficult
If costs are rising over time - firms will need to increase prices which leads to inflation
How can a rise in SRAS lead to inflation
Price level increases
