Inflation

Question 1

Define inflation

Answer 1

Inflation is a sustained increase in the cost of living or the general price level leading to a fall in the purchasing power of money

Question 2

What inflation rate does the Bank of England aim to achieve?

Answer 2

2%

Question 3

What’s the difference between inflation and disinflation?

Answer 3

Disinflation is a fall in the rate of inflation e.g from 6%to 3% prices are still rising but at a slower rate. While inflation leads to a fall in the purchasing power of money - an increase in the cost of living.

Question 4

How is inflation measured?

Answer 4

It is measured by the annual percentage change in consumer prices. In the UK the target is 2% using the CPI (consumer price inflation).
Covers 40000 households
Not well - many different locations , average households

Question 5

What are some of the issues with measuring inflation?

Answer 5

The CPI is not fully representative
Household sizes affect spending patterns
Changing qualities of goods and services
New products
Regional differences
Age
Preferences change over time

Question 6

Why is a small amount of inflation good?

Answer 6

It increases demand in the short term
Removes/reduces the risk of deflation
Boosting economic growth

Question 7

Why is it bad if prices are volatile?

Answer 7

Uncertainty- for both consumers and producers

Question 8

What can cause inflation?

Answer 8

It can come from both the demand and supply side of the economy. Inflationary pressures from the domestic economy,
fluctuations in the exchange rate,
a rise in the price of imported commodities
A rise in the rate of VAT
Government policies

Question 9

Inflation is high who does it hurt?

Answer 9

It hurts 
old people 
Poor people 
People with savings and pensions
People on fixed incomes

Exchange rate - helps foreign countries - countries exporting , hurts the UK

Question 10

Who does inflation help?

Answer 10

People with debt

Question 11

What are the demand side causes of deflation?

Answer 11

Deep fall in aggregate demand causing persistent recession/depression
Large negative output gap
High level of spare capacity

Question 12

What are the supply side causes of deflation

Answer 12

Improved productivity
Technological advances
Significant fall in wage rates
High exchange rate causing import prices to fall

Question 13

How can high inflation affect international trade?

Answer 13

A rise in imports and less exports

Question 14

Explain imported inflation

Answer 14

Inflation due to an increase in the price of imports. As imports prices increase domestic goods depending on imported raw materials prices gp up causing an increase in the general price level of all goods and services.
It can also be caused by a country’s exchange rate depreciating

Question 15

What does the term core inflation mean?

Answer 15

It is a measure of inflation that excludes certain items that face volatile price movements eg food and fuel

Question 16

What is the difference between CPI and RPI?

Answer 16

RPI includes the cost of housing, CPI does not

Because not everyone owns a house

Question 17

Give 3 examples of causes of cost push inflation

Answer 17

Components costs - raw material prices increase

Rising labour costs - wage increases, when unemployment is low, skilled workers become scarce driving up pay levels higher

High indirect taxes - a rise in the duty on alcohol, cigarettes and fuels or a rise in VAT

Question 18

Is deflation always a problem?

Answer 18

We like if it produces more at lower prices(As to the right) but otherwise it is bad 
It causes 
Holding back on spending 
Debts increase 
The real cost of borrowing increases 
Lower profit margins 
Confidence and savings 
Income distribution 

Bad deflation - AD to the left

Question 19

Why does deflation present a big challenge to macroeconomic policy makers

Answer 19

It is hard to encourage confidence during times of deflation ~ people save ~ reduces demand~ reducing supply ~ increasing unemployment