inflation Flashcards
define inflation
Inflation is the sustained increase in the general level of prices in the economy.
what are the 3 methods of measuring inflation?
- price level
- inflation rate
- consumer price index (CPI)
what is the price level ?
a measure of goods and services in the economy
what is the inflation rate?
the percentage increase in the general price level in the economy from one year to the next
what is CPI
a measure of changes in the general price level in the economy from one year to the next
what is the most widely used measure of inflation ?
CPI
list the 4 biases that lead to the CPI inflation rate being overstated
- substitution bias
- increase in quality bias
- new product bias
- outlet bias
what is substitution bias?
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.
what is increase in quality bias?
increased in price but are now superior goods, as a result CPI does not take that into account and is overstated
what is new product bias ?
CPI is only updated every 5-7 years therefore are not included in the basket of measured goods. Prices may increase or decrease
what is outlet bias
over time the number of outlets may increase, if CPI does not include this then CPI is overstated.
how is CPI measured?
changes in the retail prices of a basket of goods and services representative of consumption expenditure by typical Australian households
list the 2 causes of inflation
- demand pull inflation
- cost push inflation
what is demand pull inflation?
inflation that is caused by an increase in the aggregate demand for goods and services
what is cost push inflation
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
where do supply shocks come from?
- 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
what does inflation cost the economy?
- People on fixed incomes are likely to experience reduced purchasing power due to
inflation- Those holding wealth in paper money
- Menu costs
- Bracket creep
what are menu costs?
costs of updating prices
what is bracket creep?
wage increases due to inflation, causing higher taxation, reducing purchasing power.
inflation is a _____ in the price level
sustained increase
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 ________.
new product; the CPI overestimating the true change in the cost of living
