Inflation Flashcards
Definition of inflation
deflation
disinflation
- a sustained general rise in the price level across the economy over a period of time
- sustained general fall in price level across economy over a period of time
-rate of inflation is decreasing
Ways of measuring inflation
CPI
RPI
differences
-CPI is a weighted price index which is a measure of average prices in one period relative to average prices in a reference period called a base period.
-Family Expenditure Survey taken to measure purchasing power of UK households.
-measures changes in cost of living or cost of goods and services often purchased by a typical UK household- a weighted basket of goods is created
-updated annually
-RPI tends to have a higher value than CPI because it includes housing costs (mortgage interest payments/council tax)
-RPI was the traditional method and used by firms and trade unions however CPI has been used by the UK since 1996
-now used by all EU countries
-Bank of England measures CPI to measure against its target rate
EVALUATION: limitations of CPI
-Only representative of the average household-not accurate for households who don’t own cars for example and therefore do not spend 14% of their income on motoring HOWEVER unlikely to be able to accurately represent every household in the UK so CPI is as accurate as it can be
-Different demographics have different spending patterns and prioritise the consumption of certain goods over others.
-Different income earners experience different rates of inflation- those who spend a lot on goods will experience inflation more however those on low incomes will experience it more than those with high incomes.
CPI is slow to respond to new goods and services, even though it is updated
regularly. Changing consumption patterns are not reflected in the fixed weighting.
Core rate inflation
Change in costs of goods and services not including those from the food and energy sectors because their prices can be too volatile or fluctuate wildly.
Core inflation is important because it’s used to determine the impact of rising prices on consumer income.
REASONS FOR INFLATION: Demand-pull inflation analysis
causes of it
-Excess aggregate demand in the economy puts pressure on resources- too much money chasing too few goods
-AD shifts outwards due to an increase in a component of it
-This leads to excess demand
-This will exert pressure on prices pushing up the price level
-SRAS will stay fixed
CAUSES
-A depreciation in the exchange rate causes imports to become more expensive and exports become cheaper which causes AD to rise
- Fiscal stimulus in the form of lower taxes or more government spending meaning consumers have more disposable income, so consumer spending increases and there is higher AD as both consumption and government spending is a component of it.
- Lower interest rates makes saving less attractive and borrowing more
attractive, so consumer spending increases.
- High growth in UK export markets means UK exports increase and AD
increases.
-Higher wages mean too much money is chasing too few goods which are at a fixed level and people have higher disposable income therefore consumption increases.
REASONS FOR INFLATION: Cost push inflation analysis
causes of it
-Occurs when firms face rising costs of production.
-SRAS shifts inwards as supply decreases due to increased cost prices
CAUSES
- Raw materials become more expensive, such as when oil prices rise or there is a supply shock.
- Labour becomes more expensive which could be due to trade unions.
- Expectations of inflation- if consumers expect prices to rise, they may ask for higher wages to make up for this, which in turn could trigger more inflation.
- Indirect taxes could increase the cost of goods such as cigarettes or fuel (which are inelastic), if producers choose to pass the liability of the tax onto the consumer.
- Depreciation in the exchange rate, which causes imports to become more expensive, which pushes up the price of raw materials.
- Monopolies, using their dominant market position to exploit consumers with massive mark ups in price
REASONS FOR INFLATION: The quantity theory of money
-Growth of the money supply can also cause inflation if for instance, the Bank of England printed more money, there would be more money flowing in the economy.
-Extreme increases in the money supply usually cause hyperinflation, when the rate of inflation is incredibly high and uncontrollable.
-It is only inflationary if the money supply increases at a faster rate than real output.
-Quantitative Easing has been used by the European Central Bank to help stimulate the economy. Since the interest rates are already very low, it is not possible to lower them much more.
-The bank bought assets in the form of government bonds using the money they have created.
-This is then used to buy bonds from investors, which increases the
amount of cash flowing in the financial system.
-This encourages more lending
to firms and individuals.
-The theory is that this encourages more investment, more spending, and hopefully higher growth however a possible effect of this is that there could be higher inflation
amount of money in circulation x velocity of circulation of that money = price level x number of transactions (MV=PT)
