inflation Flashcards
how to calculate inflation
annual percentage change in consumer prices
what is the inflation target and how is it used
2% using the consumer prices index (CPI)
who sets monetary policy
the bank of england, so that inflationary pressures are controlled and inflation target is reached
what is consumer price index
a measure of the price level of the economy based on the prices of a collection of products designed to reflect the consumption basket of the average consumer
what is deflation
a decline in general price level (inflation rate below 0%)
what is disinflation
a fall in the rate of inflation, prices are still rising but at a slower rate (5% to 2%)
what is hyper-inflation
a period of very high rates of inflation, usually leading to a decline in confidence in an economies currency
define inflation rate
the annual rate of change of the average price of goods and services
what are unit labour costs
reflect total labour costs, including social security and employees pension contributions , and including the costs of self-employed labour, incurred in the production of a unit of economic output
limitations of the consumer price index
- not fully representative, 14% of the CPI is motoring costs, inapplicable for non-car owners
- spending patterns - differ from single people to families with children
- changing quality of goods and services - chjange in price may also be accompanied by change in performance of a product
- new products - CPI is slow to respond to new products and services, few items fall out/come in
when does cost-plus inflation occur
when firms respond to rising costs by incresasing their prices to protect profit margins
what can cost-push inflation be caused by
- rising unit labour costs
- higher prices for raw materials
- a depreciation in the exchange rate causing a rise in import costs
- an increases in business taxes
what does cost-push inflation look like on a digram
AD/AS diagram where supply shifts to the left
when does demand-pull inflation occur
when AD grows at an unsustainable rate leading to a positive output gap (actual GDP>potential GDP)
when there is excess demand, producers can raise their prices and thereby achieve bigger profit margins
demand-pull inflation is most likely when there is full employment of resources, when AS is inelastic
what does a demand-pull inflation diagram look like
AD/AS diagram, AD shifted to the right
why is high inflation an economic problem
inequality for lower income families
falling real incomes
negative real interest rates - intrest rates are lower that inflation
higher cost of borrowing
risks of wage inflation, rising labour costs and lower profits
builds uncertainty, low confidence
policies to control inflation
fiscal policy - higher tax + less gov. spending to lower AD
monetary policy - increased IR to lower AD
supply side policies - growing economy (shift LRAS right) reduces inflationary pressures
direct controls - wages that government can control, control water bills
define inflation
a general rise in the price level, leading to a fall in the purchasing power of money
what is the quantity theory of money and the formula, what does it assume and why is it criticised
the theory that there is a link between inflation and the amount of money circulating the economy, inflation is caused by increases in money supply
M x V = P x V
m=money supply
v= velocity of circulation (how many times money chenged hands)
p=general price level
t=number of transactions taking place
monetarists assume that V and T are constant in the short run, therefore increases in the price level are due to increases in the money supply
criticised as it assumes that the economy is at full employment, which may not be the case, and V and T may not be constant is the short run
what are the costs of inflation to individuals and the economy
reduced purchasing power - lower standard of living
less income saved as more needs to be spent
uk goods will become less competitively priced
creates uncertainty about the future therefore firms less likely to invest
business will incur administrative costs of changing prices
shoe leather costs
what is the difference between demand-side deflation and supply-side deflation
demand-side
a reduction in AD, decreasing price level
supply-side
an increase in LRAS - becuase of lower costs of production, decreasing the price level
why might deflation be bad for the economy
delays customers purchases, which will reduce demand for firms, causing less labour to be required and therefore increasing unemployment
