Inflation

Question 1

Definition of Inflation

Answer 1

Inflation means a sustained increase in the general price level leading to a fall in the purchasing power of money.

Question 2

How is the rate of Inflation measured

Answer 2

This is measured by the annual % change in consumer prices.

Question 3

Definition of RPI

Answer 3

RPI is a weighted price index, this includes the costs of housing, mortgage interest costs and council tax.

Question 4

Definition of CPI

Answer 4

CPI is also a weighted price index, which measures the monthly change in the prices of over 600 different goods and services.

Question 5

Limitations of the CPI as a measure of Inflation

Answer 5

• CPI is not fully representative - CPI represents the expenditure for the average household, therefore it would not be accurate for the non-typical household.
• Housing Costs - Housing costs vary from person to person.

Question 6

Definition of Deflation

Answer 6

When the rate of inflation becomes negative

Question 7

Problems with Inflation

Answer 7

• Costs of reducing Inflation - high interest rates needed to reduce price level, would lead to a decline in economic growth.
• International Competitiveness - higher prices will make British goods less competitive, fall in exports, fall in AD
• Confusion & Uncertainty - high inflation will make people uncertain as to what their money should be spent on; firms will be less willing to invest.
• Menu Costs - this is the cost of changing price lists.

Question 8

Definition of Demand Pull Inflation

Answer 8

This occurs when AD is growing at an unsuitable rate. Leading to increased pressure on scarce resources.

Question 9

Definition of Cost Push Inflation

Answer 9

If there is an increase in costs of firms then SRAS will shift to the left causing inflation. Firms increase their prices in order to protect their profit margins.

Question 10

Causes of Demand Pull Inflation

Answer 10

• Depreciation of the exchange rate
• Higher demand from a fiscal stimulus - changes in direct tax, will change income and thus affect consumption
• Monetary stimulus to the economy - low interest rates would encourage consumption and investment.

Question 11

Causes of Cost Push Inflation

Answer 11

• Depreciation in currency
• Rising labour costs
• Component costs
• Indirect taxes

Question 12

Advantages of Inflation

Answer 12

• Brings forward consumer spending
• Reduces real value of debt
• Allows high levels of growth and unemployment.