Inflation

Question 1

What are the effects of inflation on a worker and why?

Answer 1

They may have to work overtime to compensate for the increase in the costs of production.

Question 2

What is demand-pull inflation?

Answer 2

This is when producers increase their prices in order to choke off excessive demand. It will cause an increase in the AD components.

Question 3

What is cost-push inflation?

Answer 3

This is caused by an increase in the costs of production and therefore shifts the AS curve upwards.

Question 4

What is quantitative easing?

Answer 4

This is increasing the supply of money in an economy.

Question 5

What is a consequence of inflation in terms of exports and imports?

Answer 5

Reduced exports due to higher domestic prices and the amount of imports increase as foreign goods are cheaper - this means the current account deficit worsens.

Question 6

What is an evaluation point about the effect of inflation on exports and imports?

Answer 6

Need to consider the relative inflation as if inflation abroad is higher than domestically, the opposite effect is seen.

Question 7

What is a consequence of inflation in terms of wages?

Answer 7

Workers demand higher wages.

Question 8

What are menu costs?

Answer 8

These are the costs of changing labels, fixed capital, price lists and so on.

Question 9

What effect does inflation have on savings?

Answer 9

It erodes the value of savings.

Question 10

What effect does inflation have on those who have a fixed income?

Answer 10

They become poorer in real terms as their wages do not rise in line with inflation.

Question 11

What effect does inflation have on those who have a fixed income?

Answer 11

They become poorer in real terms as their wages do not rise in line with inflation.

Question 12

What effect does inflation have on business confidence?

Answer 12

There is increased business uncertainty as firms like low and stable inflation, this leads to a fall in investment.

Question 13

What are shoe-leather costs?

Answer 13

The costs of shopping around for cheaper deals on supplies, transferring money between accounts and so on however this won’t occur if there is low inflation.

Question 14

What are the effects of inflation on redistribution issues?

Answer 14

Those unable to bargain over wages will be relatively worse off.

Question 15

What are the psychological and political costs associated with inflation?

Answer 15

Price rises are unpopular - people may feel worse off even if their wages rise by the same amount.

Question 16

What is the wage-price spiral?

Answer 16

This is when some initial inflation prompts workers and their trade unions to demand a pay rise, this increases the firms’ costs of production and means they have to ‘push’ up their prices if they are to maintain their profit margin, the higher wages will enable workers to spend more money which increases consumption causing more inflation but as there is more inflation, workers and their trade unions demand higher wages and the whole cycle starts again.

Question 17

How can the wage-price spiral be controlled?

Answer 17

Through the government bringing the trade union and their wage demands under control.

Question 18

What does the Fisher equation of exchange state?

Answer 18

MV = PT.

Question 19

What do the letters in the Fisher equation stand for?

Answer 19

M = amount of money in circulation, V = the velocity of the circulation of that money, P = the average price level and T = the number of transactions taking place.

Question 20

What can the PT component of the Fisher equations also be seen as?

Answer 20

Aggregate demand.

Question 21

What type of equation is the Fisher equation?

Answer 21

An identity therefore it will always be true

Question 22

What is the Quantity Theory of money?

Answer 22

There is a direct and proportional link between the money supply and inflation.

Question 23

What is the Quantity Theory of money?

Answer 23

There is a direct and proportional link between the money supply and inflation.

Question 24

What is the benefit of a little inflation in terms of consumer spending?

Answer 24

It encourages consumers to buy sooner which boosts the economy.

Question 25

What is an advantage of inflation in terms of dent?

Answer 25

It erodes debt as wages will rise in line with inflation whereas debt won’t so in real terms, the value of debt has fallen.

Question 26

What is an advantage of inflation in terms of wages?

Answer 26

Rising prices makes it easier for companies to put up wages, they also give employers the flexibility not to increase wages by as much as inflation but still offer their staff some sort of rise.

Question 27

What is a disadvantage of zero inflation in terms of wages?

Answer 27

Some companies may be forced to cut wages which would not be good for morale, recruitment or productivity.

Question 28

Why does the government love inflation?

Answer 28

The government has a huge debt so it would love to see that eroded which in turn would see its own income rise.

Question 29

What does inflation do to the value of money and when is this not the case?

Answer 29

It reduces it unless interest rates are higher than inflation.

Question 30

Why is deflation bad for the government?

Answer 30

If prices and incomes fall then so does tax revenue.

Question 31

Why is deflation bad for the government?

Answer 31

If prices and incomes fall then so does tax revenue.

Question 32

What effect do expectations in terms of inflation?

Answer 32

Last year’s inflation can be a factor when people form their expectations of what lies ahead and whether to spend money on something or not.

Question 33

What is deflation?

Answer 33

The general price level is falling consistently over quite a long period of time.

Question 34

How does the vicious cycle of deflation happen?

Answer 34

People wait for prices to fall even further and get cheaper, businesses are forced to lower their prices therefore average wages begin to decline.

Question 35

Why is deflation more difficult to control than inflation?

Answer 35

There is no limit to how far you can raise interest rates whereas with deflation, there is a limit to how far you can cut interest rates.

Question 36

What causes the deflation spiral?

Answer 36

When credit is exhausted.

Question 37

What leads to growing levels of debt?

Answer 37

When buyers go on strike, people try to pay off their debt however in real terms it grows because it becomes more difficult to pay off as when prices fall, so do incomes.

Question 38

What leads to growing levels of debt?

Answer 38

When buyers go on strike, people try to pay off their debt however in real terms it grows because it becomes more difficult to pay off as when prices fall, so do incomes.

Question 39

What is the best way to precent deflation and why?

Answer 39

Cut long terms interest rates as this encourages spending and pushes firms in the direction of looking elsewhere for a better return on their money rather than buying up government debt.

Question 40

What is the result of businesses looking elsewhere for a better return on their money rather than buying up government debt?

Answer 40

They start investing in businesses that provide employment and goods and services which helps to pull an economy out of deflation or prevent them from experiencing deflation altogether.

Question 41

What happens when central banks cut their interest rates to below 0%?

Answer 41

They pay investors to borrow money and people have to pay to save.

Question 42

What is hyperinflation?

Answer 42

Very high levels of inflation - usually over 100% per year.

Question 43

What causes hyperinflation?

Answer 43

Bad government policies.

Question 44

What is the effect of hyperinflation?

Answer 44

People want to spend their money as soon as possible because it will lose its value.

Question 45

Why do we not aim for zero inflation in terms of growth?

Answer 45

Growth would be much lower than it could be.

Question 46

Why do we not aim for zero inflation in terms of debt?

Answer 46

It is easier to pay off debt when there is some inflation as wages increase but debt does not.

Question 47

Why do we not aim for zero inflation in terms of deflation?

Answer 47

Too high a risk of falling into deflation - consumers may delay spending which would worsen the situation.