Inflation Flashcards
Define inflation
A general increase in the price level (normally measured as a % change over a time period)
Which organisation measures inflation
The office for national statistics (ONS)
How often does the ONS measure inflation?
Every month
Describe how inflation is measured
The ONS purchase a basket of 700 goods. This basket is constantly updated to reflect current demand trends. Each item is weighted according to how significant a change in its price would be to households. The price of the basket is compared to the same month last year, and the percentage change is announced
What are the two types of baskets?
- Retail price index (RPI)
- Consumer price index (CPI)
What is the difference between the RPI and the CPI?
The RPI includes household expenses (like mortgages, rent and council tax), and these are not included in the CPI basket
What is deflation?
When prices are generally falling
Why is deflation bad?
People will delay spending as they wait for prices to continue falling. Businesses will then cut prices to try and increase demand. This can lead to a dangerous downward spiral
What is disinflation?
This is where prices are still rising, but at a slower rate than they used to
What are the two causes of inflation?
Cost push and demand pull
Explain how a demand pull causes inflation
If aggregate demand increased but aggregate supply remained the same, prices would increase in order to reach a new equilibrium
Give some examples of a coat of production
Raw materials and labour costs
Explain how a coat push causes inflation
If the firm’s can’t afford to stay in the market or supply as much, aggregate supply will shift inwards. If aggregate demand remains constant, prices will have to rise for a new equilibrium to be reached
Define nominal and real in terms of inflation
Nominal does not account for inflation, whereas real does
What is a real interest rate?
An interest rate that takes inflation into account
List the effects of inflation
- workers will seek a pay rise that is in line with inflation
- the government need to try and help people through the situation without making it worse
- the government are under pressure to increase benefits in line with inflation, which is extremely expensive
- inflation can be positive for government, because it erodes the value of debt
- inflation could cause higher interest rates for the government due to uncertainty, which could increase the value of debt
- could be good for savers as it leads to higher interest rates. However, the real interest rate is often negative, meaning this gets eroded
- poverty levels could increase if wages can’t keep up
- businesses will see their cost of production rise
- businesses will be less willing to invest because of the uncertainty
How do the Bank of England’s inflation targets help control inflation?
They become self fulfilling because people act as if they are true, this is because the Bank of England is a legitimate, trusted body
What is an index number?
Take data for a period of time for each year, the index gives the percentage change from the base number
What are weights in terms of inflation?
Allow us to adjust raw data to account for the relative importance of items, such as those items bought frequently in the case of a price indexm
Why does the CPI tend to give a lower rate than the RPI?
Because it excludes things like mortgage payments and tax changes
A cost increase will do what to the aggregate supply curve?
Shift it upwards
What are the three main causes of cost push inflation?
- an increase in the price of oil and other commodities
- wage increases
- a fall in the value of sterling, which makes imports more expensive
What is the impact of inflation on firms?
- there is uncertainty about future costs, prices and revenue, and also about the availability of finance
- the damaged confidence leads to caution and an unwillingness to invest
- rising interests rates could disincentives borrowing
- demand will reduce if inflation decreases spending power
- workers may expect a pay rise,.which could lead to a wage price spiral
- imports become more expensive
- exporters will benefit, as their goods will seem cheaper on the international market
What is the impact of inflation on individuals?
- those on fixed incomes will suffer
- those relying on the state pension may actually benefit from the triple lock. However, if the prices of what they buy rise faster than the basket of goods, they will still suffer
- anyone in debt will see the real value of their debt fall
- savers often experience a negative rate of interest in real terms, so the real value of their savings fall
What is a the impact of inflation on government?
- inflation helps the government by reducing the real value of debt, but this could be offset by higher interest rates making debt more expensive
- they must walk the tight rope of helping people through the crisis while also working to tighten the monetary supply so as to not make the problem worse
