Inflation

Question 1

Define demand pull inflation

Answer 1

When aggregate demand is growing unsustainably, there is pressure on resources so producers increase their prices to earn more profit. It usually occurs when resources are fully employed

Question 2

Define price-wage spiral

Answer 2

When price level increases so the cost of living increases so workers demand higher wages, shifting SRAS to left which leads to higher prices even further

Question 3

Pros and cons of inflation

Answer 3

Pros

• reduce real value of debt so improves inequality
• protection from deflationary spiral

Cons

• inflation wont affect nominal value of savings but real wage will decrease, worsening inequality
• price-wage spiral can lead to hyperinflation

Question 4

Hyperinflation definition

Answer 4

when the rate of inflation rises above 50%

Question 5

Define deflation

Answer 5

A sustained decrease in the general
price level

Question 6

Causes of deflation

Answer 6

reduction in aggregate demand

increase in aggregate supply

Question 7

What does the inflation rate tell us?

Answer 7

The percentage change in the general price level

Question 8

Multiplier ratio formula

Answer 8

Change in real GDP / Initial Injection

Question 9

Define disinflation

Answer 9

A decrease in the rate of inflation as the general price level is increasing but at a slower rate than before

Question 10

Define nominal income
Define real income

Answer 10

Nominal income - how much you earn

Real income - nominal income adjusted for the effects of inflation - how much your income is really worth

Question 11

What are the main triggers for demand-pull inflation?

Answer 11

• Lower interest rates - makes saving less attractive so borrowing becomes more attractive therefore AD increases
• Fiscal stimulus in the form of lower taxes and an increase in government spending means consumers have more disposable income so consumption increases which increases AD
• Depreciation in the exchange rate means imports become more expensive while exports become cheaper which causes AD to rise
• High growth in UK export markets means exports increases and AD increases

Question 12

Define cost-push inflation

Answer 12

When the cost of production and raw materials increases, leading to higher prices for goods and services

Question 13

What is the macroeconomic objective for inflation in the UK?

Answer 13

The inflation rate to be at 2% + or - 1% in order to maintain price stability

Question 14

Define CPI and how it measures inflation

Answer 14

Consumer price index measures purchasing power of households using the family expenditure survey. From this a basket of goods is created and weighted according to how much income is spent on the goods. The CPI measures the average price change of these goods and is updated annually to account for changes in spending patterns

Question 15

Limitations to using CPI

Answer 15

• The basket of goods is only representative of the average household, so it is not
  accurate for all households
• Different demographics have different spending patterns
• CPI does not include mortgage repayments, despite most income going towards that
• Increase in the price level is often accompanied by other improvements such as improvement in quality of goods and services which is ignored by CPI
• Despite being updated annually, CPI is slow to respond to new goods and services and it is hard to make historical comparisons, since technology was of a vastly different quality

Question 16

Define RPI and what it is

Answer 16

Retail price index is an alternative measure of inflation to CPI

Unlike CPI, RPI includes housing costs such as repayments on mortgage interest and council tax so RPI tends to have a higher value than CPI