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Economics Theme 2 Knowledge Organiser > Inflation > Flashcards

Inflation Flashcards

1
Q

What is inflation?

A

a sustained increase in the general price level

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2
Q

What is deflation?

A

a sustained decrease in the general price level.

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3
Q

What is disinflation?

A

a reduction in the rate of inflation (the inflation rate falls but the price level is still rising, but at a slower rate).

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4
Q

What is cost-of-living?

A

a measure of changes in the average cost for a household of buying a basket of different goods and services.

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5
Q

What is the inflation target?

A

a target set by the government which the central bank should aim to achieve eg in UK it is CPI inflation = 2% +/- 1% point

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6
Q

What is the Consumer Price Index?

A

The ‘headline’ rate of inflation is the annual % change in the CPI. The CPI tracks changes in the prices of a basket of goods and services purchased by an average household.

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7
Q

What is the CPI inflation formula?

A

CPI Inflation Rate = [(Current CPI - Previous CPI) / Previous CPI] × 100

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8
Q

What is basket of goods and services?

A

things a typical household buys; updated each year to keep it relevant

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9
Q

What is the price survey?

A

prices of the goods and services in the basket are monitored each month. The price of each representative good/service in the basket is weighted according to the proportion of income a typical household spends on it

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10
Q

What is CPIH?

A

similar to CPI but also monitors owner occupier housing costs (OOH),in its basket. These are the costs associated with owning, maintaining and living in one’s own home.

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11
Q

What is RPI (Retail Price Index)?

A

the basket of goods/services includes some items not in the CPI, such as council tax & mortgage interest payments; it is often used to calculate increases in welfare benefits, pensions, index-linked bonds and wage negotiations; in a period of rising interest rates it typically gives a higher rate of inflation than the CPI

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12
Q

What is “core” inflation?

A

sustained increase in prices of goods in the basket, excluding goods suchas energy, food, alcohol and tobacco which can have volatile prices.

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13
Q

What are limitations of the CPI inflation measure?

A
  • CPI inflation is only calculated for an ‘average’ family
  • It does not consider quality of goods/services
  • Needs regular updating to reflect changes in patterns of spending
  • International comparisons may not be accurate if other countries do not calculate inflation in the same way
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14
Q

What are costs of inflation?

A
  • Shoe leather costs
  • Menu costs
  • Fall in real incomes
  • Uncertainty
  • Redistributional effects
  • Loss of international competitiveness
  • Increase in inflation expectations
  • Danger of wage-price spiral
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15
Q

What are shoe leather costs?

A

costs of shopping around when prices change rapidly

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16
Q

What are menu costs?

A

costs of redoing menus, parking changes, price labels & lists

17
Q

What is fall in real incomes?

A

if wages do not keep pace with prices, real incomes fall

18
Q

What is uncertainty?

A

consumers and businesses may reduce their spending causing unemployment and weaker growth

19
Q

What are redistributional effects associated with inflation?

A

savers get a lower real rate of return, those on fixed incomes lose out, workers in the gig economy may not be able to negotiate real wage increases; fiscal drag increase tax paid if thresholds are frozen

20
Q

What is a loss of international competitiveness from inflation?

A

weaker current account on the Balance of Payments as exports become relatively more expensive and imports relatively cheaper

21
Q

What is an increase in inflation expectations?

A

people will aim for bigger pay rises if they expect higher inflation, which can add to business costs and prices

22
Q

What is the danger of the wage price spiral?

A

if workers demand big pay rises

23
Q

What are benefits of a low rate of inflation?

A
  • A low but steady rate implies aggregate demand is running ahead of aggregate supply, incentivising business investment and growth
  • Reduces the real value of debt
  • Allows negative interest rates
  • Helps labour markets work more efficiently without a need to cut nominal wages because real wages can fall
  • Makes malign deflation less likely
24
Q

What is demand pull inflation and show what it looks like?

A

Demand-pull inflation is inflation caused by excess AD in the economy.
Producers can raise prices and increase their profits
AD shifts right causing the price level to rise from PL1 to PL2

25
Q

What are causes of demand pull inflation?

A
  • Lower interest rates
  • Lower income tax
  • Rapid income growth
  • High consumer confidence
  • Positive wealth effects
  • Easy credit (cheap and accessible credit)
  • Depreciation of the currency
26
Q

How can a growth in the money supply cause inflation?

A

Monetarists argue that inflation is caused by excessive growth of the money supply - ‘too much money chasing too few goods’.
Firms and consumers may spend their excess money, thus raising AD; the demand for labour could rise because it is derived from demand for goods increasing wages and costs of production.

27
Q

What is cost push inflation and what does it look like?

A

Cost-push inflation is inflation caused by increases in the costs of production in the economy.
Can cause stagflation – when economy stagnates as price level rises
SRAS shifts left/up causing the price level to rise from PL1 to PL2

28
Q

What are causes of cost push inflation?

A
  • Rapid wage rises/higher labour costs
  • Skill shortages
  • Increasing input costs (raw material, energy)
  • Higher commodity prices
  • Food price inflation
  • Indirect tax rises
  • Depreciation of currency (imported inflation)
29
Q

What is the difference between anticipated and unanticipated inflation?

A

Inflation tends to be more damaging when is it unanticipated; the costs of inflation to economic agents are higher when there is an inflation shock eg a sudden sharp increase in energy or food prices.
Having an inflation target, as is the case in the UK, can help with ‘inflationary expectations’ and ‘anchor’ inflation to the 2% target.

30
Q

What is demand side deflation and show what it looks like?

A

Deflation caused by fall in AD ie inflation caused by a lack ofAD in the economy.
Producers have to reduceprices and their profits fall
AD shifts left causing the price level to fall from PL1 to PL2; larger negative output gap

31
Q

What are costs of deflation?

A
  • Lower AD causes over supply
  • Lower prices for goods and services cuts cash flow and profits for businesses; consumers may delay their spending; businesses may cut investment
  • Businesses reduce production; cyclical unemployment rises
  • Rise in real value of debt
  • Real interest rates may rise reducing consumption and investment
32
Q

What are causes of “malign” deflation?

A
  • Negative demand shock (eg credit crunch in global financial crisis 2008-9)
  • Global recession
  • Appreciation of currency causing fall in net exports
  • Falling asset prices (negative wealth effect)
  • Contractionary fiscal and or monetary policy
33
Q

What is supply side deflation and what is it caused by?

A

Deflation caused by an increase in short run aggregate supply ie deflation caused by decreases in the costs of production in the economy;
SRAS shifts right causing the price level to fall from PL1 to PL2.
LRAS could also shift right.

34
Q

What are causes of ‘benign’ deflation?

A

Technological advances
Improvements in productivity
Falling price of commodity prices
Falling price of energy prices
Globalisation/economies of scale
Cheaper/more skilled labour (perhaps from immigration)

35
Q

What are benefits of deflation?

A
  • Falling prices for consumers
  • Increase in real incomes
  • Increased spending power for those on fixed incomes
  • Improved international competitiveness
  • Falling asset prices make housing more affordable for first time buyers!

Economics Theme 2 Knowledge Organiser (24 decks)

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