Inflation Flashcards
Inflation Definition
The persistent and appreciable rise in the general level of prices
Deflation Definition
Deflation is the persistent and depreciable lower in the general level of prices. This was experienced in the 2020 covid recession due to decreasing petrol prices and free childcare.
Consumer Price Index (CPI)
Measures changes in the prices of a basket (sample) of goods and services bought by Australian households from one quarter to the next. At the end of each year an annual figure is also calculated from these quarterly figures.
how to calculate inflation
price in year 2- price in year 1/price in year 1 x 100
Demand Pull Inflation
High levels of demand caused by high levels of total aggregate expenditure.
High levels of aggregate demand are indicated by:
- High levels of spending on construction and consumer durables.
- Excess demand for labour in some sectors of the economy, forcing up wages in those sectors and thus prices.
- Excess money supply (when the rate of growth of money supply is faster than the rate of growth of real output)
Cost Push Inflation and what causes it
Cost push inflation occurs when rising input costs are passed on to consumers, who then pay higher prices for final goods and services. Periods of cost push inflation can be attributed to events such as:
- Wages rising faster than worker productivity (people getting paid more but not producing more output).
- Rising import prices (when our dollar is low it costs more to buy things from overseas).
- Rising oil/petrol prices (oil is a key component in production and distribution).
- Natural disasters such as flood or drought, which sometimes cause shortages of agricultural products.
Explain the effect of inflation on real income
Inflation reduces the purchasing power if incomes do not rise in line with prices. If price rises faster than incomes, real income falls, and households cannot purchase the same volume of goods and services they were able to in the past.
How does inflation affect interest rates
Inflation affects interest rates because lenders must maintain a margin between their true cost of funds and the rate at which they lend those funds. If the IR was 7% and prices were rising at 8%, the purchasing power of money would be falling faster than the rate at which a loan was repaid, so no one would be willing to lend money!
How does inflation affect International Competitiveness (IC)?
IC is influenced by relative inflation levels. A country is set at a disadvantage if the domestic inflation rate is greater than its competitors. As it will make the cost of the product higher than its competitors.
Define Hyperinflation
Hyperinflation is rates of inflation above 30% per annum.
Relationship between inflation and unemployment
The relationship between inflation and unemployment is often described using the Phillips Curve, a concept in economics that suggests an inverse relationship between the two.
This means that when inflation rises, unemployment drops. Higher unemployment, on the other hand, equates to lower inflation. When more people are working, they have the power to spend, which leads to an increase in demand.
