Inflation Flashcards
Define inflation
A sustained increase in the APL
Define disinflation
Exists when the rate of inflation decreases which means that prices continue to rise but at a decreasing rate
Define deflation
When the average price level of a country decreases, negative rate of inflation
What is used to measure inflation?
CPI
Define consumer price index
A weighted average of the prices of the goods and services that the typical consumer buys, expressed in index number form
Which equations are used to determine the weighting of goods?
Weights and w= expenditure on good/ total expenditures
inflation rate 2022= CPI22 -CPI21/ CPI21 * 100
What are the limitations of the CPI in measuring inflation?
- This typical consumer mentioned in the definition is no actual person. It makes is problematic for governments to determine whether they should increase pensions as it is a mix of old, young, poor, rich etc
- Some products may have become more expensive, but their quality may have improved to much that they are effectively cheaper
- New products enter our lives almost daily but are included in the CPI after a long delay
- People prefer to buy goods online as it is cheaper and so it causes an overestimation of true inflation
- If a good becomes more expensive then consumers will tend to switch to cheaper substitutes so inflation is overestimated
What are costs of high inflation rate?
- Inflation increases the uncertainties that businesses may face
- Purchasing power of those earning fixed money decreases
- Low income families cannot easily borrow from the banks
- If actual inflation> anticipated inflation, then borrowers will gain income at the expense of lenders. The money they will be borrowing back to lenders will be worthless.
- Hurts the exports of a country
- Inflation may induce people to save less
- Inflation is noise- it distracts the signalling power of relative price changes that is responsible for resource allocation
What are benefits of inflation?
Mid inflation slowly reduces the real wage and so the cost of labour to firms. This is important as money wages do not easily adjust downwards
Inflation also reduces the real value of debt
Define Demand pull inflation
Inflation resulting from AD rising as an economy reaches full employment
What are causes of demand-pull inflation?
- Profligate government spending
- When the central bank increases money supply too fast
- Sudden surge in exports
- Households and firms can be overly optimistic
- Inflationary expectation are considered a most important driving force of inflation. If business expect prices to increase, then they will set their prices higher increasing inflation as a result
Illustrate the demand-pull inflation graph
See notes:)
Define cost pull inflation
Inflation resulting from adverse supply shocks shifting AS to the left; usually rising commodity prices are responsible, especially oil prices or rising wages as a result of powerful labour unions
What are causes of cost-push inflation?
- A sustained and significant increase in the price of the oil. If the price of oil increases, production cost increases to AS decreases
- PC may increase bc other commodity prices increase
- Powerful labour unions in many countries have been successful in increasing money wages for their members so production costs increases
- depreciation of exchange rate- increases the domestic prive of imports
Illustrate cost-pull inflation
see notes:)
