Inflation

Question 1

What is Inflation

Answer 1

A sustained increase in the average price level over a given period of time

Question 2

Define Disinflation

Answer 2

A sustained decrease in the rate of inflation over a given period of time

Question 3

Define Deflation

Answer 3

A sustained decrease in the average price level over a given period of time

Question 4

Does a fall in inflation = a fall in prices

Answer 4

No

Only when there is deflation does the general price level fall

Question 5

What is the CPI

Answer 5

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

Question 6

Limitations of the CPI

Answer 6

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

Question 7

What is RPI

Answer 7

Measures CPI + Living Costs (National Income, Mortgage Payments, Rent)

Question 8

How can CPI be used to measure inflation

Answer 8

Changes in price level can be used to calculate inflation from different years through a base year of prices being chosen.

Question 9

Inflation Effects on Consumers

Answer 9

Less to spend if income does not rise with inflation

Low inflation = better if in debt, worse if you’re lending

Question 10

Inflation Effects on Firms

Answer 10

Harder to export - inflation
Hard to plan
Consumers postpone orders - deflation

Question 11

Inflation Effect on Government

Answer 11

Fail to change excise tax in line with inflation - lost revenue
Fail to change personal income tax allowances - tax payers have less money

Question 12

Inflation Effect on Workers

Answer 12

Deflation = Job Losses

Wage Increase not in line with Inflation - Worse off + decreased living standards

Question 13

Equation of Inflation using CPI

Answer 13

Number in Period / Number in Base Period x 100 = % Change in Inflation

Question 14

How does inflation redistribute income

Answer 14

Away from certain groups in the economy and towards other groups

Question 15

When does redistribution arise

Answer 15

Situations where certain groups lose some purchasing power and become worse off and vice versa

Question 16

Groups that lose from inflation

Answer 16

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

Question 17

Groups that gain from inflation

Answer 17

Borrowers/Debtors

Payers of fixed income or wages

Payers of income or wages that increase less rapidly than the rate of inflation

Question 18

What is the money illusion

Answer 18

Some people feel better off when their nominal income increases - even though the price level may increase at the same rate or even faster

Question 19

What is demand pull inflation

Answer 19

Excess demand in the economy which leads to the price level rising

Question 20

Situations leading to demand pull inflation occuring

Answer 20

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

Question 21

What is cost push inflation

Answer 21

Rising costs

Question 22

Situations where cost push inflation occurs

Answer 22

Wages and salaries rise

Imports can rise

Higher prices

Raise in indirect tax rates or reduce subsidies

Question 23

What do firms try to do with cost push inflation and potential drawbacks to this method

Answer 23

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

Question 24

How can a rise in SRAS lead to inflation

Answer 24

Price level increases