Inflation

Question 1

Inflation

Answer 1

• The sustained rise in general price
  level over time.
• The cost of living increases
• The purchasing power of money
  decreases.

Question 2

Deflation

Answer 2

Average price level in the economy falls. (Negative inflation rate)

Question 3

Disinflation

Answer 3

Falling rate of inflation, the average price level still rising but to a slower extent.
- Purchasing power increases

Question 4

Demand pull inflation

Answer 4

When aggregate demand is growing unsustainably, there’s pressure on resources.
Producers increases their price to earn more profits.

Question 5

Main triggers of demand pull inflation.

Answer 5

• Depreciation in the exchange rate
• Lower interest rates
• High growth in UK export markets.

Question 6

Depreciation in the exchange rate

Answer 6

Imports more ££
Exports less £££
AD increases

Question 7

Lower interest rates

Answer 7

Saving less attractive
Borrowing more
Consumption rises

Question 8

High growth in UK export markets

Answer 8

UK exports increase
AD increases

Question 9

Cost push inflation

Answer 9

When firms face rising costs

Question 10

Cost push inflation main triggers

Answer 10

• Changes in the world commodity prices.
• Labour becomes more expensive
• Expectations
• Indirect taxes
• Deprecation in the exchange rate
• Monopolies

Question 11

Changes in world commodity prices

Answer 11

(Domestic inflation)
Increases cost of production

Question 12

Labour becomes more expensive

Answer 12

Trade union

Question 12

Expectations

Answer 12

Asking for higher wages as they are expecting inflation.

Question 13

Indirect taxs

Answer 13

Could increase the costs of good such as cigarettes or fuel (pass onto consumer)

Question 14

Depreciation in the exchange rate

Answer 14

Causes imports to become more expensive and pushes up the price of raw materials.

Question 15

Monopolies

Answer 15

Using their dominant market position to exploit consumers with high prices.

Question 16

Who is affected by inflation

Answer 16

• Consumers
• Firms
• The Government
• Workers

Question 17

How are consumers affected?

Answer 17

• Regressive effect means those of low incomes are hit the hardest (necessities).
• If consumers have loans, the repayment value will be lower (real value of debt increases).

Question 18

How are firms affected?

Answer 18

• IR higher less investment
• Workers demanding higher wages
• Unpredictable inflation - reduces business confidence (less investment)

Question 19

How are the government affected?

Answer 19

The Gov. will have to increase the value of the state pension and welfare benefits (increased cost of living).

Question 20

How are workers affected?

Answer 20

• Real incomes fall with inflation (less disposable)
• Redundancies if firms face higher costs.

Question 21

Uncertainty

Answer 21

If inflation is high and unpredictable, firms may find it difficult to undertake future planning as they will be uncertain of future gov. policy, input costs, prices and profits.
- Therefore, inflation results in lower investment, economic growth and employment.

Question 22

Reduced international competitiveness.

Answer 22

if exchange rates do not change, higher inflation reduces the competitiveness of a country’s goods.
- (reducing exports and increasing imports)
- Worsening the balance of payments, economic growth and employment.

Question 23

Inefficient resource allocation

Answer 23

• Inflation reduces the effectiveness of prices as a signal to owners of factors of production
• Difficult to distinguish relative prices.

Question 24

Reduces real incomes and savings

Answer 24

• Inflation reduces the purchasing power of money.

Question 25

Menu costs

Answer 25

Updating price lists - waste of scarce resources.

Question 26

Shoe leather costs

Answer 26

High inflation imposes a cost on holding cash. - money will only hold value if saved in accounts with positive real interest rates. (ir>infaltion)
time consuming to make frequent withdrawals

Question 27

Redistribution

Answer 27

unforeseen inflation will reduce the real value of debt repayments.
Redistributing wealth from lender to borrower.
Most evident in public sector borrowing where the real value of the national debt falls over time.

Question 28

What is fiscal drag

Answer 28

The gov. generating higher tax revenues as more earners drift into the higher tax bracket and pay higher % of their income.
- Because gov. don’t increase tax thresholds in line with inflation.
- Also saves the gov. money as fewer students’ families have an income low enough to qualify for financial support.

Question 29

How can employers cut costs

Answer 29

Offering below inflation pay rises
masking the fact wages have been cut in real terms.

Question 30

How do borrowers gain from inflation

Answer 30

• Inflation reduces the real value of loan repayments.
• This may particularly benefit:
  Those with mortgages (house prices aline with inflation but debt value falls)
• The UK gov. with a very large national debt.