Inflation Flashcards
What are the 2 definitions of inflation?
-General increase in the average price level from one year to the next
-Fall in the value of money
What is an index?
A system that measures changes in a set of variables that change by different amounts in different directions. Shows average movement
What are the 3 types of index?
- consumer price index = price changes
- FTSE 100 = share prices
- sterling trade weighted index = exchange rates
What is demand pull inflation?
Occurs when there is an excess aggregate demand - positive output gap.
What are the main causes of demand pull inflation?
- Depreciation in the exchange rate
- reduction in direct and indirect taxation
- rapid growth of the money supply as a consequence of increased bank & building society borrowing
- rising cc and increase in rate of growth of house prices (wealth effect)
- Faster rates of economic growth in other countries
What is excess demand?
Too much money chasing too few goods
What is cost push inflation?
Occurs when costs of production are increasing
What are the causes of cost push inflation?
- external shocks (eg wage price spiral)
- depreciation in exchange rate
- Acceleration in wages
- higher indirect taxes
- rising labor costs
- wage price spiral
What leads to an inward shift in the SRAS curve?
- firms raise prices to product their profit margins
- wages often follow prices
- A rise in inflation can leach to rising inflationary expectations
What are 2 evaluative statements for AD rising?
- Depends on the size of exchange rate depreciation
- depends on the PED for imports
- Uk jobs will be created
- may not matter if Uk is below inflation target
What is productivity?
The rate of output per worker per day
It measures the efficiency of factors of production in the production process
What does higher productivity do?
- Produce goods and services at a lower cost per unit
- Increase total output from our scarce factor resources
- helps to bring about economic growth for a country in the long term
What factors explain the productivity gap?
- Relatively low rates of capital investment
- low rates of spending and research and development
- not investing enough in skills of labour force
What is the wealth effect (house prices)?
Os assets that people own go up in value eg. Houses that person her access to additional borrowing that increases spending and increases AD and PL
What is fishers equation of exchange?
MV=PT
what doe MV=PT stand for?
M - money supply
V - velocity of circulation
P - average prices
T - number of transactions
What does MV=PT show?
GDP
What are some drawbacks of MV=PT?
- V and T are not constant in the UK due to supply side policies
- difficult to measure T as some are illegal (hidden economy)
- M also difficult to define
why are printing more money and borrowing not inevitable?
you can:
- sell govt assets
- use surplus from previous years
What is narrow money?
measure of value of coins and notes in circulation and other money equivalents that are easily convertible into cash such as short term deposits in the banking system
What is broad money?
broad money is a measure of the total amount of money held by households by companies in the economy (mainly commercial bank deposits)
What are some causes of inflation? (Sleepover)
- increasing money supply (bc purchasing power falls)
- higher govt spending (multiplier effect)
how is govt spending a cause of inflation?
-By spending on the demand side of the economy focusing on increasing AD - supply not increasing at the same rate therefore there is excess demand driving prices up
-Multiplier effect: gov spending is an injection into the economy and has a bigger final outcome on national income
-Component of AD
what is transitionary income?
working over time (extra income)
high earners have a higher rate of transitionary income and tend to save most of it (higher MPS, lower savings ratio)
what is the marginal propensity to save?
how much of our transitionary income we save
Why do we not want inflation?
- menu costs
- fixed incomes lose purchasing power
- uncertainty
- savings are eroded
- possibility of wage spiral
- loss of international competitiveness
- breakdown of the price mechanism
What does uncertainty depend on? (for firms)
- how much of our raw materials are domestic/foreign
- may matter less for products with an inelastic demand, as increased costs can be passed onto price
- how much of our raw materials are bought in advance on a contracted basis
- how much stock the business holds for the future
What does savings being eroded depend on?
- interest rates relative to inflation
- made worse if there is disincentive to save and AD increases further
- less money in banks available for investment
What does people losing purchasing power depend on?
- amount of people on fixed incomes (index linked CPI)
- may act as an incentive to take up work to reducing unemployment
What does loss of international competitiveness depend on?
- economy’s reliance on exports
- prices inflation of other countries
- price elasticity of demand of exports
What is trade union power?
Extent to which trade unions can get what they want
Why is cost push inflation worse than demand pull?
- ad is easier to influence than sras
- AS is less elastic
- cost push leads to job losses
- may be due to imported costs increasing
Why is the inflation target at 2%?
- low, predictable, anticipated inflation provides psychological incentives for firms and individuals
- individuals see a rise in pay
- firms see a rise in revenue
- if the rise for both firms and individuals is both the same, this is money illusion
What is money illusion?
Worker sees a pay rise by 2%
Simultaneously prices rise by 2%
Workers focus on the 2% pay rise rather than the PL rising and will continue spending
What is deflation?
Fall in the average price level from one year to the next
Bad if AD falls and good if SRAS rises
Why is it good if SRAS increases to cause deflation? (Benign)
Creates an extension in AD which increases employment (benign deflation)
Why is bad if AD falls to cause deflation?
Increases unemployment (malignant deflation)
what is disinflation?
prices are still rising but at a slower rate
what is government spending split up into?
capital and current
what is capital spending?
spending that will benefit the economy for years in the future e.g. hospital (infrastructure) LR assets
what is current spending?
spending that will benefit only in the current financial period e.g. pay the nurse, funded by taxation - SR asset
what is the matching concept?
matching the benefit of the asset against the cost of that asset
what is net investement?
net investment is the investment after the depreciation of the asset is removed from the total investment
e.g. capital accumulation(100bn) - depreciation(35bn)=net investment
