Inflation

Question 1

define Inflation!

Answer 1

a steady and persistent increase in the general level of prices.
its the rate at which your money looses its ability to buy things.

Question 2

who calculates inflation in Ireland?

Answer 2

the CSO (central statistics office) employs 94 part-time price collectors who collect about 53,000 prices in 84 locations throughout the country in the second Tuesday of every month.

a further 3,000 are collected from postal, email and telephone inquiries along with internet price collections.

these prices are used to calculate inflation!

Question 3

how can we measure inflation?

Answer 3

to measure the change of price of one good over time we simply look at the 2 prices and compare them.

simple price index formula :
price of any year divided by price of base year by 100

Question 4

how can we examine changes in the general price level

i.e. of many goods ?

Answer 4

composite price index

1. choose a base year and let all prices be equal to 100
2. select goods and find prices of all years
3. construct the simple price index for each good
4. multiply the simple price index by the weight of the good (proportion of income spent on it)
5. add to get the composite price index of the current year

Question 5

what is the CPI ?

Answer 5

consumer price index

the official measure of inflation in Ireland. it is a price index that shows the current cost of purchasing the same identical basket of goods with the base year (starting point)

Question 6

how is the CPI calculated?

Answer 6

1. National average shopping basket
2. expenditure categories
3. household budget inquiry
   4 decide on a base year and find prices
   5.collect prices of the currant year

Question 7

what are the economic uses of the consumer price index?

Answer 7

measures the rate of inflation,
international comparison,
indicator of the countries/ governments performance,
indexation of savings and investments,
used in wage negotiations,
used by the government to index tax brands

Question 8

what precautions should be taken when using the CPI ?

Answer 8

its an index of the average consumer,
not a cost of living index,
lags behind consumer trends and fashions,
static weights,
quality changes in products,
substitution of products

Question 9

what factors cause inflation?

Answer 9

demand pull factors

cost push factors

imported inflation

government-induced inflation

Question 10

explain how demand pull factors cause inflation?

Answer 10

if aggregate demands are greater than aggregate supply, prices will be forced upwards.
this can happen where there is relatively early access to bank credit and where government increases expenditure.
basically, too much money is chasing too few goods and excess demand pulls up prices.
…tends to happen when the purchasing power of consumers increases at a faster rate than the production of goods and services.

Question 11

explain how cost push factors cause inflation!

Answer 11

if a company has an increase in its costs of production, it will pass on this increase by raising the selling price of the final good sold to the consumer.

Question 12

explain how imported inflation causes inflation in a country?

Answer 12

many raw materials used in the production process ar imported.( similar to cost push inflation)

similarly, if the value of the euro falls relativel to another currency, then it costs us more to purchase the same quantity of goods than it did before the devaluation.

Question 13

how can government-induced inflation affect a country?

Answer 13

when the government, through its budgetary policy, decides to increase VAT rates ( indirect taxes), thus raising prices.
on the other hand, lowering income tax rates (direct taxes, e.g. PAYE ) gives greater spending power to consumers, potentially causing price inflation.

Question 14

what remedies against inflation are available?

Answer 14

fiscal policy

monetary policy

partnership agreements

Question 15

how can fiscal policy prevent inflation?

Answer 15

increasing direct taxation would have the effect of reducing demand, as consumers would have less disposable income.

governments tend to not favour this option as it could lead to unemployment, a fall in welfare and a decline in future wealth-creating capacity of the economy.

Question 16

how can monetary policy prevent inflation?

Answer 16

controlling the money in the circulation.

reducing the amount of credit made available by the banking sector would reduce demand but curtails future wealth creation and employment.
increasing the rate of interest ( price of money) reduces the demand for loans and hence discourages investment and consequently leads to unemployment.

this option is not within the remit of the Irish government , but by the ECB

Question 17

how can partnership agreements regulate inflation?

Answer 17

attempt to limit wage increases will help dampen cost push inflation.

any government that reduces the minimum wage rate could reduce business costs and hence inflation.

any reduction in energy cost, i.e. price of oil/ electricity can keep costs low and prices stable.

Question 18

what problems are caused by high inflation?

Answer 18

lower standard of living,
fixed income holders,
speculation encouraged,
borrowing encouraged,
wage demands,
loss of international competitiveness,
savings discouraged,
difficulty attracting foreign direct investment (FDI) ,
increase in unemployment

Question 19

what is deflation?

Answer 19

when there is a general decree in the average level of prices. this sounds great, but can damage an economy. if all prices are steadily declining, then consumers may postpone buying goods/services, causing consumer demand to fall and thus affecting employment and growth. a company might postpone investing and the economy would suffer.

Question 20

what are the benefits of price stability?

Answer 20

1. consumers tend to spend their money,
2. government revenues could increase with more (in-)direct taxes,
3. no demand for wage increases
4. pensioners will see their purchasing power being maintained
5. savings in the economy may increase, leading to investment.

Question 21

what is the constant tax price index?

Answer 21

a price index that keeps the indirect tax part of a price increase constant…

main use = wage negotiations

Question 22

what is the HICP?

Answer 22

harmonized index of consumer prices

almost all nations calculate their CPI. Eurostat, along with member states, produces a HICP.

presently 90% of the total CPI basket is included. but it excludes mortgage interst, building materials, concrete blocks, union subscriptions, motor taxation and non-service elements of motor and house insurance.

it is the correct measurement for the Eu, but not for national purposes.

Ireland looks very good in the HICP, cause the most expensive items are not included.

Question 23

what are the economic effects if the supply of money grows at a faster rate than a country’s production of goods/services ?
(quantitative easing)

Answer 23

1. inflation goes up,
2. more imports,
3. fall in the exchange rate- value of euro could fall,
4. enterst rates will fall

Question 24

what are the economic effects if the supply of money grows at a slower rate than a country’s production of goods/services.

Answer 24

1. deflation & moderation in price levels
2. unemployment & falling demand
3. less imports
4. interst rates increase
5. fall in exchange rate