Inflation 5 (J) done Flashcards
inflation:
a persistent and appreciable rise in the general level of prices. reduces the rate of income demand
inflation is measured:
by consumer price index. compares current prices with prices of earlier period (base period)
inflation rate formula:
CPI year 2 - CPI year 1
________________________ x 100
CPI year 1
largest group in basket
housing
then health, education, food
headline rate of inflation:
CPI calculated, includes major price increases caused by one off price fluctuations
underlying rate of inflation:
excludes ‘non-market’ and unusual forces on prices
demand pull inflation:
occurs when the value of AE is greater than the value of total output (AD > AS) (high levels of AD come from any C + I + G (X-M))
demand pull: too much money chasing…
too few goods
demand pull: AD/AS model
an increase in demand shifts the AD curve to the right from AD1 to AD2, pushing up the price from P1 to P2
demand pull inflation on bus. cycle
upswing or peak
causes of demand pull inflation:
- high level of growth in foreign countries
- inflationary expectations (pre GST)
- monetary policy (too much credit in the economy)
sources of demand pull inflation
any increase in C + I + G + (X-M) as economy approaches full employment
cost push inflation:
occurs when increases in the cost of production are passed onto consumers in the form of higher prices
sources of cost push inflation:
- world price of resources increase
- increase in taxes and charges
- growth in wages in excess productivity
cost push inflation: AD/AS model
Increases in cost will move the supply curve to the left from AS1 to AS2, resulting in an increase in the price level from P1 to P2.
inflation translates into a fall…
in the value of money and therefore the level of disposable income
two effects of inflation
- output effects on income, output and employment
- redistribution effects of income and wealth in the economy
4 output effects
- confidence
- international competitiveness
- government policy
- labour market
output effects on what model?
AD on AD/AS model
output effects: confidence
- inflation increases uncertainty about future outcomes.
- businesses will be less likely to invest (productive investments decrease, safe investments increase)
- consumer confidence reduced, increases savings, decreases spending so may reduce output and employment
output effects: international competitiveness
- if our inflation rate is higher than trading partners/ competitors, imports become cheaper and exports become more expensive (reduces international competitiveness)
- reduce national output and employment, decrease terms of trade
output effects: government policy
- tighter monetary policy (increase in interest rates), may reduce investment and consumption and negative impact on output and employment
- tighter fiscal policy - reduces gov expenditure in attempt to lower aggregate demand
- may reduce output and employment
output effects: labour market
- capital for labour substitution (increasing wage rates causes uncertainty whereas cost of purchasing capital is certain
- occurs mainly in unskilled labour markets
2 redistribution effects:
- wealth and income
- income
