Inflation Flashcards
Define Inflation
Increase in the average price level of goods and services
Define disinflation
Decrease in the RATE of inflation
Define deflation
Decrease in the average price level of goods and services over time.
What is demand pull inflation?
Likely to occur when economy is approaching/at full employment. In this situation an increase in AD or any of its components will increase prices and increase demand pull inflation.
What is cost-push inflation?
Arises when costs of production to a nation firms increases, which will shift the SRAS to the left.
What are the most likely causes of cost-push inflation?
Increase of oil prices Increase in nominal wage Depreciation of the currency (leads to an increase in the price of imports) Natural factors/wars Higher taxes
Anticipated or unanticipated inflation:
Anticipated: people can take steps to protect themselves and companies can adjust prices and lenders can adjust interest rates.
Unanticipated: occurs when economic agents make errors in their inflation forecasts. Causes losses in real incomes and a redistribution of income and wealth from one group in society to another.
What is money illusion:
People may think that they are getting wealthier however due to rising inflation it creates an illusion. It is most likely to occur when inflation is unanticipated.
Consequence of inflation: impact of inflation on savers
Rise in general price level means money loses its value. Savers will lose out if nominal interest rates are lower than inflation - leading to negative real interest rates.
Consequence of inflation: inflation expectations and wage demands
People demand higher wages as they try to maintain their real living standards. Business then increase prices to maintain profit and higher prices then put further pressure on wages.
‘Wage-price spiral’.
Consequence of inflation: arbitrary re-distributions of income
Hurts employees in jobs with poor bargaining power. Low paid jobs with little/no trade union protection may see the real value of their pay fall.
Consequence of inflation: Business investment, competitiveness and unemployment.
Budgeting becomes difficult due to uncertainty and may reduce panned capital investment spending.
Loss of international competitiveness
As costs of production rise, firms reduce their output and therefore less labour is required.
What are the overall consequence of deflation?
The price level of a economy normally don’t fall.
What do the prices of an economy rarely fall?
Due to labour contracts, unions etc firms rarely lower their wages. They won’t lower the price of their products because it will cut into their profits.
Oligopoles fear price wars if one firm lower prices.
Firms want to avoid incurring menu costs especially if it’s a short term change.
What are the other consequences of deflation?
Uncertainty - firms can’t forecast their costs/revenues
Menu coats - cost of firms peint get new menus, catalogues etc.
Causing cyclical unemployment - deflation discourages spending by consumers, AD falls, etc…
Risk of bankruptcies and financial crisis - recession.
