inflation

Question 1

what is inflation

Answer 1

Inflation is a rise in the general level of prices of goods and services. this does not mean all prices rise some may rise while others may fall or stay constant

Question 2

what is the consumer prise index

Answer 2

step 1: complete the living costs and food survey to find what average families buy
step 2: create a basket of several hundered goods and services based on the results of the survey
step3: give weight to each ite, in the basket based on the amount typically spent on each item
step 4: check prices of the last time and calculate a percentage change in prices
step 5: add up all the percentage changes and calculate an average change. this is inflation

Question 3

advantages of low inflation (6)

Answer 3

• real income is maintained as higher purchasing power leads to better standard of living
• UK firms are more price competitive
• encourages FDI
• inefficient firms cannot hide behind high prices
• better industrial relations leading to less risk of higher wage claims and wage spiral inflation
• increased consumer confidence

Question 4

what is the role of the monetary policy committee (5)

Answer 4

• responsible for price stability in the economy
• set interest rate
• attempt to keep inflation at 2%
• they met to review the current inflation rate and market conditions
• they are responsible for quantitive easing

Question 5

advantage of using CPI

Answer 5

many other countries in the EU use this measure meaning it is easy to make international comparisons

Question 6

consumer price index including housing costs

Answer 6

this measure includes housing costs e.g. council tax and is favoured by the ONS who produce the inflation and unemployment figures

Question 7

retail price index (4)

Answer 7

this was the main measure of inflation until 2004

it had a target of 2.5% for the BoE to maintain

it is similar to the CPI but has a different variation of items used and this does include some housing costs

it is still used to decide how much increases in pensions or train fares should be

Question 8

how is the real rate of inflation calculated

Answer 8

nominal rate of interest - rate of inflation

Question 9

what is the nominal

Answer 9

the monetary value before the rate of inflation has been considered

Question 10

what does real rates mean regarding inflation

Answer 10

the monetary value after the rate of inflation has been considered

Question 11

effects of high inflation on individuals (5)

Answer 11

• disposable income is reduced for those on those on low wages due to fiscal drag
• reduces real income if individuals do not receive a pya rise that is above or the same level of inflation meaning they can purchase less with the same amount of money effectively they are worse off
• makes savers worse off when inflation is above interest rate as it reduces the value of savings
• increase in unemployment as firms may lay off a labour surplus in order to remain competitive
• reduces living standard for those with a fixed income or those which do not rise as fast as inflation rates

Question 12

effects of high inflation on firms (5)

Answer 12

• reduced competitiveness in domestic and foreign markets may force firms out of business
• reduces real value of profits for firms which operate in markets where there is foreign competition. foreign competitors may produce in economies where inflation is lower
• reduces the willingness to invest as inflation creates uncertainty about future costs and prices e.g. firms may cancel plans for future projects
• it encourages inefficiency as firms operating in markets with little competition may mask inefficiency by raising prices
• increased menu costs - changing price lists

Question 13

effects of inflation on the economy (5)

Answer 13

• reduces economic growth if firms stop investing
• distorts the balance between indirect and direct taxation as income tax revenue rises with inflating income. expenditure taxes tend to fall in real value
• inflation can create an exception that it will continue and this expectation will ensure that it does e.g. pay rises leading to wage spiral inflation
• inflation makes UK goods more expensive abroad leading to a fall in exports damaging the BoP
• high inflation has been followed by recession

Question 14

what is deflation (4)

Answer 14

• deflation is a fall in the general level of prices
• it occurs because demand falls making it harder to make profit leading to unemployment
• people stop spending as deflation means products will be cheaper in the future
• falling share and house prices reduces people’s wealth and confidence in making purchases

Question 15

advantages of inflation (3)

Answer 15

• borrowers gain because they have the use of money now when its purchasing power is greater
• some firms are able to increase prices and profits before they pay out higher wages
• people earn more so pay more income tax

Question 16

what is cost push inflation

Answer 16

when the cost of making products increases so business raise prices to protect their profit margins

Question 17

what is wage push inflation

Answer 17

when the increased costs for firms is specifically staff costs

Question 18

how is cost push inflation caused (3)

Answer 18

• increases in taxation
• increase in costs of raw materials
• wage increases

Question 19

what is demand pull inflation

Answer 19

occurs when aggregated demand is greater than aggregated supply meaning prices rises in response to excess demand

occurs when the economy is growing too quickly

Question 20

what is demand pull inflation caused by (4)

Answer 20

• rising consumer spending fuelled by tax cuts or low interest
• sharp increases in government spending
• rising demand for resources by firms
• booming demand for exports

Question 21

Monetary inflation

Answer 21

occurs when the money supply is increasing at a faster rate than output

can be caused by quantitative easing to fund government spending

Question 22

imported infaltion

Answer 22

if price of imported goods increases so does the price of domestic goods, using imports as raw materials also increases

caused by inflation in other countries or depreciation of their exchange rate

Question 23

expectations of inflation

Answer 23

if people believe prices will rise in the future wages will increase leading to wage spiral inflation

Question 24

fiscal policy to reduce demand pull inflation (3)

Answer 24

increase taxes on individuals leading to a fall in their disposable income which decreases demand for goods, lowering demand pull inflation
however can cause slower growth and unemployment

decreasing government spending by reducing public sector pay which is likely to decrease demand for products reducing inflation

Question 25

monetary policy to reduce demand pull inflation (3)

Answer 25

increasing interest rates discourages borrowing so spending by consumers which reduces demand and reduces inflation. makes it more expensive for business to borrow money so they are less likely to expand thus less job opportunities

higher mortgage interest payments reduces the homeowners disposable income and their ability to spend which reduces demand pull inflation

lower interest rates so business can borrow with less risk which reduced their costs

Question 26

what is sticky inflation

Answer 26

combination of stubborn high inflation and stagnant growth

Question 27

supply side policies to reduce inflation (4)

Answer 27

• improving the productive capacity of the economy to reduce unemployment
• improve education and training programs
• reduce trade union power to take industrial action which leads to less being produced
• encourage business to grow and invest

Question 28

policies to reduce demand pull inflation (2)

Answer 28

fiscal: increase income tax to reduce demand. increase VAT to reduce demand. reduce gov spending to reduce amount in the circular flow

monetary: increase interest rate to deter from borrowing

Question 29

policies to reduce cost push inflation (4)

Answer 29

fiscal: reduce indirect taxes and lower costs of production. reduce corporation tax to allow investment to reduce costs for firms

monetary: reduce interest rates for firms to borrow, lowering costs

supply side: invest in education and training to increase productivity. invest in infrastructure to reduce transport costs. deregulation of markets to improve competitiveness

exchange rates: use interest rates to increase the pound value to lower costs for firms