Inflation Flashcards
Measures of Economic Growth
Inflation Vs Deflation Vs Disinflation
Inflation - A sustained rise in general price level.
Deflation - A sustained fall in general price level
-Sign of stagnation in an economy
–> COVID-19 caused severe recession as a result come countries experienced deflation
Disinflation - Fall in rate at which general price level (inflation) is rising
–> e.g. Inflation falling from 3% to 2%
What is Consumer Price Index
The Price level, a weighted average of items people spend money on
- A measure of inflation, does not include housing costs (e.g. rent, mortgage)
What are the Key features of CPI
- Used to measure the rate of Inflation, and used for Inflation targeting
- Used for international comparisons of rate of Inflation
- CPI is an Index number (Base level = 100, numbers shown are relative to that)
- Inflation shown is year to year
What formula is used to calculate the % change of inflation in CPI
(Change in number ➗ OG Number) x 100
How is CPI calculated?
- Survey collects info from 7,000 households using self-reported purchases
- Price survey undertaken (done once a month on price changes of commonly used goods)
- Weights are assigned to each item average household buys –> reflects proportion of income spend on each item
- △P x Weight = Price Index
–> rate of inflation measured by %△ in index over consecutive years - CPI does NOT include housing costs –> e.g. Rent, or Mortgage payments
Limitation of CPI as measure of rate of Inflation (%)
- Does NOT include housing costs e.g. rent or mortgage
–> these are significant items of expenditure - Some people do not have representative spending patterns –> will experience cost of living rises by more or less than average
- Attempts made to account for changes in quality (mobile Phones) or weight (less g’s) but adjustments are imprecise
- Only changes once a year –> sudden changes not reflected
- Sampling issues –> self-reported households may not provide accurate info
What is CPIH
CPI + Housing costs
- Now preferred measure of Inflation
What is RPI (Retail Price Index) + reliability
- Includes intrest payments on mortgages and council tax
- Not as reliable as CPI or CPIH for international comparison
What are the two umbrella causes of inflation?
- Demand-pull Inflation
–> Caused by Increase in AD –> e.g. Interest rate cuts, people spending more money - Cost-push Inflation
–> When AS Decreases –> e.g. Cost of Production Increase
5 Causes of Demand-pull Inflation
(Hint 3 ↑, 2 ↓)
- ↑Business and Consumer Confidence
- ↑Government Spending
- ↑ Exports (relative to Imports)
- ↓ in Intrest Rates
- ↓ (depreciation) in Exchange rates (will cause an increase demand for exports [relatively cheaper], and reducing demand for imports)
5 Causes of Cost-push Inflation
Hint 4↑, 1↓
- ↑ Price of Raw materials e.g. oil
- ↑ Taxes on Businesses
- ↑ Minimum wage / wage generally (increase cost of Labour)
- ↑ Regulations e.g. environmental, health and safety (↑Cost)
-↓ In Exchange rate (Imports more Expensive)
What is Monetarism
e.i. Secret Third option
- belief the sole cause of Inflation is increase in the Money Supply
–> associated with increase in AD and Milton Friedman
What rate should inflation be at + what does it say if it is not
Should be at 2%
- Inflation measures success of economy
–> if too high or low, sign economy has problems
Effects of High Inflation on Consumers?
(3)
- Fixed Incomes –> Inflation implies income in real terms fall (especially for those with Fixed incomes [Uni students or Pensioners])
- Savings –> Rate of Inflation is higher than Interest rates, real value of savings decreases
+ Loans / Mortgages –> if Rate of Inflation higher than Interest rates, R. Value falls - Making it more manageable
Effects of High Inflation on Firms?
- Fall in Exports –> Inflation rate is higher than trading partners then International competitiveness falls.
–> Exports become more expensive, Imports seem cheaper –> Worsen balance of trade - Uncertainty –> High Inflation makes budget setting dificult –> fall in investments
- Lower Profits –> Cost-push Inflation, decrease in profits -> lower investments
–> However, some inflation is desirable, as first can increase revenue e.g. Demand-pull inflation as profits↑ - Impact on Monetary policy –> High inflation cause increase interest rates –> fall in investment by firms (costs of borrowing increase)
