Inflation Flashcards
Inflation
- The sustained rise in general price
level over time. - The cost of living increases
- The purchasing power of money
decreases.
Deflation
Average price level in the economy falls. (Negative inflation rate)
Disinflation
Falling rate of inflation, the average price level still rising but to a slower extent.
- Purchasing power increases
Demand pull inflation
When aggregate demand is growing unsustainably, there’s pressure on resources.
Producers increases their price to earn more profits.
Main triggers of demand pull inflation.
- Depreciation in the exchange rate
- Lower interest rates
- High growth in UK export markets.
Depreciation in the exchange rate
Imports more ££
Exports less £££
AD increases
Lower interest rates
Saving less attractive
Borrowing more
Consumption rises
High growth in UK export markets
UK exports increase
AD increases
Cost push inflation
When firms face rising costs
Cost push inflation main triggers
- Changes in the world commodity prices.
- Labour becomes more expensive
- Expectations
- Indirect taxes
- Deprecation in the exchange rate
- Monopolies
Changes in world commodity prices
(Domestic inflation)
Increases cost of production
Labour becomes more expensive
Trade union
Expectations
Asking for higher wages as they are expecting inflation.
Indirect taxs
Could increase the costs of good such as cigarettes or fuel (pass onto consumer)
Depreciation in the exchange rate
Causes imports to become more expensive and pushes up the price of raw materials.
Monopolies
Using their dominant market position to exploit consumers with high prices.
Who is affected by inflation
- Consumers
- Firms
- The Government
- Workers
How are consumers affected?
- 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).
How are firms affected?
- IR higher less investment
- Workers demanding higher wages
- Unpredictable inflation - reduces business confidence (less investment)
How are the government affected?
The Gov. will have to increase the value of the state pension and welfare benefits (increased cost of living).
How are workers affected?
- Real incomes fall with inflation (less disposable)
- Redundancies if firms face higher costs.
Uncertainty
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.
Reduced international competitiveness.
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.
Inefficient resource allocation
- Inflation reduces the effectiveness of prices as a signal to owners of factors of production
- Difficult to distinguish relative prices.
Reduces real incomes and savings
- Inflation reduces the purchasing power of money.
Menu costs
Updating price lists - waste of scarce resources.
Shoe leather costs
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
Redistribution
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.
What is fiscal drag
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.
How can employers cut costs
Offering below inflation pay rises
masking the fact wages have been cut in real terms.
How do borrowers gain from inflation
- 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.
