Inflation

Question 1

what is inflation

Answer 1

the annual rate of change of the GENERAL PRICE LEVEL within the economy in a year

Question 2

what happens to the value of money after inflation

Answer 2

when prices rise, value of money falls aka money buys less

Question 3

how do you calculate inflation

Answer 3

CPI + FES

Question 4

what does CPI stand for

Answer 4

consumer price index

Question 5

What does FES stand for

Answer 5

family expenditure survey

Question 6

what are the disadvantages of CPI

Answer 6

excludes house related payments eg. council tax, mortgage interest payment

Question 7

what is FES

Answer 7

a survey which calculates the typical basket of goods, which reflects the SPENDING PATTERNS of an AVERAGE HOUSEHOLD

Question 8

What is the effect of necessities in the FES

Answer 8

They give a high weight in the overall price index

Question 9

What does CPI measure

Answer 9

the changes in the price level of market basket of consumer goods and services purchased by households

Question 10

what did CPI used to be called

Answer 10

RPI (retail price index)

Question 11

PROBELMS WITH MEASURING INFLATION (5) CHECK ANSWER

Answer 11

1. prices are recorded + annual % change in index is measured HOWEVER there can be changes due to excess supply = cost less
2. FES does not represent the whole population (pensioners is different to youths) as DIFFERENT PEOPLE spend their money DIFFERENTLY
3. Weights are reviewed every year but NEW products come onto the market more often
4. differences in regional living costs are not published (more expensive to live in London than in the suburbs)
5. CPI cannot ensure changes in quality of goods (cars have improved over the years and therefore OVERSTATE true inflation.

Question 12

what are the effects of inflation on consumers (4 STEPS)

Answer 12

1. consumers buy less as everything more expensive and money value is falling: cannot afford to buy as many products = less aggregate demand but only for luxuries as you need necessities
2. however many not effect much as INCOME MAY ALSO INCREASE and inflation increases (same rate or faster) = no fall in demand
3. however rich people don’t care because they are rich = more divide between rich and poor
4. UK goods more expensive = foreign purchases fall / stop = less demand = less UK exports

Question 13

what are the effects on inflation on businesses (4)

Answer 13

1. fall in aggregate demand + income if products aren’t a necessity
2. high inflation = fall in business confidence = fall in investments in economy = recession
3. fall in aggregate demand for UK businesses located abroad / trade abroad - however may not effect our exports if OTHER economies are worse
4. countries becoming more developed = COSTS FOR BUSINESSES GO UP (aka raw materials they use) = increase price = decrease in aggregate demand

Question 14

what is disinflation

Answer 14

occurs when there is a fall in the level of inflation (prices are going up but not as much as they were before)

Question 15

what are the causes of disinflation (2)

Answer 15

1. a raw material or production that has a big effect on the products falls in price = lower (but still increasing) price
2. the price of a main product that has an effect in the average of good prices i.e. food has fallen

Question 16

what is deflation

Answer 16

occurs when there is a persistent and sustained reduction in the general level of prices within an economy

Question 17

causes of deflation (2)

Answer 17

1. fall in aggregate demand within economy (e.g. due to unemployment = people can’t afford much = less aggregate demand)
2. the price of imports decreasing for an economy = able to buy more raw materials from abroad

Question 18

what is demand pull inflation

Answer 18

when there is excess aggregate demand = businesses raise price to increase profit margins

Question 19

what are the causes of demand pull inflation (4)

Answer 19

1. fast growth in aggregate DEMAND for credit / borrowing
2. high levels of consumer spending
3. APS falling ( could be due to low interest rates)
4. WEALTH EFFECT

Question 20

what does APS stand for

Answer 20

Average propensity to save

Question 21

what is the wealth effect

Answer 21

when the value of consumer’s possessions increases (i.e. price of houses increases) = consumers feel richer = likely to spend more

Question 22

what is the cause of cost push inflation

Answer 22

when the costs of production are increasing:
the prices of RAW MATERIALS (i.e. oil) increases = businesses need to spend MORE money to obtain the SAME AMOUNT of raw materials = production cost increases = businesses would increase their selling price in order to MAINTAIN a CERTAIN profit

Question 23

what are the causes of costs of production cost increasing (3)

Answer 23

1. external shock (natural disasters they are not prepared for)
2. depreciation in exchange rate (pound decrease = businesses (who obtain raw materials abroad) need to spend MORE money to obtain the SAME amount of RAW MATERIALS = production cost increase)
3. acceleration in wages (businesses need to pay more wages to their employees)

Question 24

what are the negative economic consequences of inflation? (3)

Answer 24

1. WAGE PRICE SPIRAL - rise in prices ( b/c of inflation ) = workers ask for higher wages to continue to maintain their standard of living BUT increase in wage demand = higher prices as firms want to PROTECT profit margins
2. inflation = fall in real value of money = discourages saving (fall in APS) + = people on fixed incomes lose out (i.e. pensioners) = increase in inequality gap
3. CREATES UNCERTAINITY = more unemployment + discourage investment = harm economic growth

Question 25

what are the positive economic consequences of inflation (3)

Answer 25

1. reduces real cost of borrowing (i.e. for households, firms + gov)
2. means that national debt may be reduced = opportunity cost of interest payments can be used to improve national services
3. real cost for borrowing for firms is lower encourages investment