inflation

Question 1

define inflation

Answer 1

Inflation is the sustained increase in the general level of prices in the economy.

Question 2

what are the 3 methods of measuring inflation?

Answer 2

1. price level
2. inflation rate
3. consumer price index (CPI)

Question 3

what is the price level ?

Answer 3

a measure of goods and services in the economy

Question 4

what is the inflation rate?

Answer 4

the percentage increase in the general price level in the economy from one year to the next

Question 5

what is CPI

Answer 5

a measure of changes in the general price level in the economy from one year to the next

Question 6

what is the most widely used measure of inflation ?

Answer 6

CPI

Question 7

list the 4 biases that lead to the CPI inflation rate being overstated

Answer 7

1. substitution bias
2. increase in quality bias
3. new product bias
4. outlet bias

Question 8

what is substitution bias?

Answer 8

it is assumed that the price changes but not the amount purchased. If price increases, quantity demanded increases. When price changed are significant the assumption no longer holds.

Question 9

what is increase in quality bias?

Answer 9

increased in price but are now superior goods, as a result CPI does not take that into account and is overstated

Question 10

what is new product bias ?

Answer 10

CPI is only updated every 5-7 years therefore are not included in the basket of measured goods. Prices may increase or decrease

Question 11

what is outlet bias

Answer 11

over time the number of outlets may increase, if CPI does not include this then CPI is overstated.

Question 12

how is CPI measured?

Answer 12

changes in the retail prices of a basket of goods and services representative of consumption expenditure by typical Australian households

Question 13

list the 2 causes of inflation

Answer 13

1. demand pull inflation
2. cost push inflation

Question 14

what is demand pull inflation?

Answer 14

inflation that is caused by an increase in the aggregate demand for goods and services

Question 15

what is cost push inflation

Answer 15

inflation that arises as a result of a negative shock - that is, anything that causes a decrease in the aggregate supply of goods and services

Question 16

where do supply shocks come from?

Answer 16

• Increases in import prices
  
  • Increases in wages
  • Increases in indirect taxation
  • Increases in monopolistic power in product markets - input prices
    
    • Major natural disasters, such as: droughts, floods and earthquakes

Question 17

what does inflation cost the economy?

Answer 17

• People on fixed incomes are likely to experience reduced purchasing power due to
  inflation
  
  • Those holding wealth in paper money
  • Menu costs
    
    • Bracket creep

Question 18

what are menu costs?

Answer 18

costs of updating prices

Question 19

what is bracket creep?

Answer 19

wage increases due to inflation, causing higher taxation, reducing purchasing power.

Question 20

inflation is a _____ in the price level

Answer 20

sustained increase

Question 21

Assume that the base period for CPI calculations is 1980. In Australia in 2011, around 24 per cent of people accessed the internet through a broadband connection that did not exist in the 1980s. This potential for bias in the CPI is referred to as ________ bias and results in ________.

Answer 21

new product; the CPI overestimating the true change in the cost of living