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Economics (Tina) > Inflation > Flashcards

Inflation Flashcards

1
Q

Inflation

A

Persistent rise in the general/average price level in the economy which has been sustained over a period of time.

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2
Q

Price stability

A

A government objective which tries to contain the rise in the general price level to an absolute minimum. (An acceptable rate is 3% or less).

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3
Q

Disinflation

A

Disinflation is when the inflation rate is falling but there is still inflation

Fall in inflation rate

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4
Q

Deflation

A

Persistent fall in the general/average price level in the economy which has been sustained over a period of time.

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5
Q

Hyperinflation

A

Rapid, excessive, out of control rise in price ( > 50% rise )

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6
Q

Measuring Inflation

A

Price index = (cost of today’s basket / cost of basket in base year) x 100

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7
Q

Measuring Inflation 2/Calculating Inflation

A
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8
Q

Price index

A

An average measure of price changes for a sample of consumer goods and services, excluding producer goods and services.

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9
Q

Poll 1: A fall in the inflation rate from 5% to 3% means…

A. Prices will fall
B. Prices will continue to rise
C. The value of money will be increasing
D. Those on fixed incomes will be better off.

A

B

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10
Q

Poll 2: Which of the following statements is correct?

The following table shows the year on year percentage change in the price index of a country between 1990 and 1994.

A. The price level was at its lowest in 1994
B. The price level was at its lowest in 1990
C. The price level was at its highest in 1990
D. The price level fluctuated between 1990 and 1994

A

B

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11
Q

Poll 3: The above table shows the annual inflation rate of a certain country. It follows that…

A. The general level of prices fell in 1996
B. The country became more internationally competitive throughout the period
C. Prices fell throughout the period
D. Prices rose throughout the period

A

D

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12
Q

Calculations you need to know

A

SL: The inflation rate from a set of data using quantities purchased as weights in the CPI

HL: A weighted price index, using a set of data provided

Discuss: What are some limits of measuring inflation using CPI?

Not everyone is buying the same basket of goods and you can’t calculate every product

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13
Q

Formulas

A
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14
Q

Demand pull inflation

A

When too many people chasing too few goods = increase price

Demand pull inflation is usually present when the economy is close to full employment.

The economy is growing too fast.
People have too much money = want to spend more

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15
Q

Causes of demand pull inflation

A

AD > economy’s production capacity = causing price rises.

Resources are fully employed and demand grows, shortages lead to inflation.

Excess AD results from increased components of AD (AD = C + I + G + (X - M)):

  • Increased consumer spending (e.g., high consumer confidence).
  • Increased business investment.
  • Increased government spending.
  • Increased export revenue (e.g., rising foreign incomes).
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16
Q

Cost push inflation

A

When the cost of production increases and is passed on to the consumer by an increase in price

Things becoming expensive to make –> firms has to raise prices to make up

17
Q

Causes of cost push inflation

A

Groups within econmy use power to drive prices up –> higher costs –> raise price

Wage push inflation - workers demand for more wage –> more costs –> raise price to compensate

Import push pressures - imports is more expensive –> firms that relies on imports has to raise price to compensate

Cost push pressures - cost of FOP increase –> price increase

18
Q

Good deflation vs Bad deflation

A

Good deflation - increase in SRAS

Bad deflation - decrease in AD

19
Q

Inflationary spiral

A

Increase wealth → Increase AD → Prices go up → Workers demand higher wages to keep up → Businesses raise prices again to cover wage increases → Prices go up →…

20
Q

Deflationary spiral

A

Prices fall → Businesses make less money → They cut wages or lay off workers → People have less money to spend → Demand falls → Prices fall → …

21
Q

Why is inflation a problem?

A
  • Redistributes income from savers to borrowers.
  • Erodes fixed incomes (e.g., pensions).
  • Devalues money.
  • Creates “menu costs” for businesses.
  • Causes “shoe leather costs” for consumers.
  • Discourages saving.
  • Encourages wage demands and industrial disputes.
  • Reduces global competitiveness.
22
Q

Costs of High Inflation

A
  • Uncertainty
  • Redistributive effects (e.g., hurts savers, benefits borrowers)
  • Erodes savings
  • Damages export competitiveness
  • Slows economic growth
  • Inefficient resource allocation
23
Q

Costs of Deflation

A
  • Uncertainty
  • Redistributive effects
  • Deferred consumption
  • High cyclical unemployment and bankruptcies
  • Increases real value of debt
  • Inefficient resource allocation
  • Policy ineffectiveness
24
Q

Redistributive effects

A

Redistributive effects occur when money shifts between groups.

Lenders lose from unanticipated inflation as repayments have less purchasing power, while borrowers benefit by repaying with devalued money.

25
Q

Costs/Effects of Inflation - 1

A

Inflation reduces the purchasing power of money

Consumers are able to buy less and less with their incomes = fall in ‘real income’. The people most likely affected are:

  • Consumers on fixed incomes (e.g. pensions)
  • Consumers with life time savings (they will get eaten away)
  • Consumers whose wage rises lag behind price rises

Key term: inflation-linked incomes

26
Q

Costs/Effects of Inflation - 2

A

Redistributes income and wealth

27
Q

Costs/Effects of Inflation - 3

A

Inflation can lead to balance of payments difficulties (this is the effect on their international competitiveness)

If a country’s inflation rate is greater relative to the rest of the world then:

  • Prices of exports are more expensive to overseas buyers = discourages foreigners from buying
  • Domestic consumers encourage to buy imported goods = Domestic production fall –> unemployment
  • Imports > Export = current account deficit –> increased foreign debt.
28
Q

Costs/Effects of Inflation - 4

A

Inflation can distort the pattern of resource allocation and discourage investment and production.

  • Investors may prefer safe assets (e.g., gold, real estate) over capital goods.
  • Uncertainty about costs, competition, and government policies –> companies invest less
  • Less investment = fewer factories –> lower production, and fewer jobs in related industries
  • Banks may raise nominal interest rates to keep real rates positive.
29
Q

Effects of (bad) Deflation

A

Unemployment: Low demand leads to layoffs, potentially causing a deflationary spiral.

Deferred consumption: Low consumer confidence reduces spending.

Low investment: Reduced profits and business confidence discourage investment.

Rising debt burden: Increased debt value leads to more bankruptcies.

Uncertainty: Declining confidence levels and labor unrest.

Positive effect: Potential improvement in productivity and output.

30
Q

Solving: demand pull inflation at less than full employment

A

Reduce AD:

  • Contractionary Monetary Policy
  • Contractionary Fiscal Policy
31
Q

Evaluation for Contractionary Fiscal Policy in solving demand pull inflation at less than full employment

A

Pros:

  • Inflation is solved

Cons:

  • Economy is in recession
  • Unemployment increase
  • Difficult to cut government spending (vaccines, etc..)
32
Q

Evaluation for Contractionary Monetary Policy in solving demand pull inflation at less than full employment

A

Pros:

  • Increase price of money, directly address the cause of inflation

Cons:

  • Increase interest rate –> decrease investment –> country may lose competitive advantage in production
33
Q

Solving: demand pull inflation at full employment

A

Increase max capacity of production –> Increase LRAS

Supply side policies:

  • Remove minimum wage legislation
  • Subsidies to infant industry
  • Decreasing unemployment benefit
  • Reduce profit tax
34
Q

Solving: Cost push inflation

A

Supply side policy (ways to decrease costs for firms):

  • Reduce taxes (indirect, direct, profit)
  • Reducing wage rises
  • Reduce/remove minimum wage legislation

Contractionary Monetary Policy:

  • Less demand –> less pressure to raise wages –> less costs
  • Reduce spending from high interest rate –> firms invest and spend less –> less costs

Economics (Tina) (21 decks)

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