Inflation

Question 1

What is inflation?

Answer 1

Inflation ⬆️- sustained rise in general price level

Question 2

What is a consequence of inflation?

Answer 2

Purchasing power of 💴 ⬇️ as prices of 🚘 ⬆️ … same amount of 💴 buys ⬇️

Question 3

What is deflation?

Answer 3

Deflation ⬇️- fall in general price level

Question 4

What are the evaluation points of deflation?

Answer 4

1) 👎- bad for ppl with debts- real payments ⬆️
2) 👎- ✋ 🛑 firms investing abroad 🌎 - value of output ⬇️ relative to initial costs- A.D ⬇️ (ppl wait to buy 🚘- price coming ⬇️)

Question 5

What is disinflation?

Answer 5

Disinflation- fall in rate of inflation- ⬆️ BUT at slower rate

Question 6

What are the evaluation points of disinflation?

Answer 6

• 👍- inflation under control

- 👎- investment & confidence ⬇️ in economy

Question 7

What is CPI?

Answer 7

Consumer price index (CPI)- measures general price level- ✖️ measure inflation BUT CPI inflation = price levels used to calculate inflation

Question 8

What is the UK’s CPI inflation target?

Answer 8

2% (+-1%)

Question 9

How do you calculate CPI?

Answer 9

2 surveys must be done:
Survey 1:
- Annually
- LCF (Living Costs & Food Survey) carried out by ONS (Office of National Statistics) to determine contents of virtual ‘basket’ of 🚘 & 🧹
- 7000 🏠holds conduct self reported diaries of purchases
- What ppl spend 💵 on- proportion of expenditure (food etc) used to assign weighting

Survey 2:

• Monthly
• 120,000 total prices gathered- find change in price of 650 common 🚘/🧹
• Change in price index used to calculate inflation

Question 10

What are the negatives of using CPI as measure of inflation?

Answer 10

1) ✖️ include 🏠 costs (mortgages, rent etc)- take up large part of spending
2) CPI measures cost of living for average household- ✖️ top/bottom 4% or pensioners
3) ✖️ everyone responds to surveys- may not respond accurately about spending
4) If quality of 🚘 changes then CPI ✖️ accurate- not comparing like with like- e.g. better 📱- ⬆️ spending due to better 🚘 quality ✖️ due to inflation

Question 11

What is RPI?

Answer 11

Retail price index

Question 12

What does RPI include that CPI doesn’t include?

Answer 12

House prices

Question 13

What is a potential negative of RPI?

Answer 13

✖️ reliable for international comparisons

Question 14

What are the causes of inflation?

Answer 14

1) Demand pull inflation

2) Cost push inflation

Question 15

What is demand pull inflation and what is it caused by?

Answer 15

Demand pull inflation- rightward shift in AD

- Caused by an increase in C,I,G or X-M (net exports)

Question 16

What is cost push inflation and what is it caused by?

Answer 16

Cost push inflation- leftward shift in AS

- caused by ⬆️ production costs e.g. ⬇️ in exchange rate

Question 17

What is the role of the money supply in inflation?

Answer 17

• Inflation caused by ⬆️ in money supply greater than ⬆️ in real output (too much 💵 chasing too few 🚘- means value of 💵 ⬇️ as 🚘 remain the same)
• … inflation controlled through money supply- e.g. through interest rate

Question 18

What are the effects of inflation on consumers?

Answer 18

1) 👎- Real value of savings ⬇️
2) 👎- Purchasing power of those on fixed incomes (e.g. pensioners) ⬇️
3) 👍- debtors/those with loans benefit as real value of debt ⬇️

Question 19

What are the effects of inflation on producers/firms?

Answer 19

1) 👎-✖️ international competition- exports expensive & imports cheap
2) 👎- ⬆️ uncertainty- with ⬆️ costs, ⬆️ interest rates likely … ✖️ investment (repayments ⬆️ expensive)
3) 👎- ⬇️ investment from abroad 🌎- foreign ✖️ invest in a 💴 ⬇️ in value

Question 20

What are the effects of inflation on the government?

Answer 20

1) 👍- ⬇️ cost of borrowing- ⬇️ real interest rate- real value of national debt ⬇️ with inflation
2) 👍- ⬇️ chance of deflation- deflation-> underinvestment & ⬇️ spending

Question 21

What are the effects of inflation on workers?

Answer 21

1) 👎- Workers might expect ⬆️ wages BUT firms ✖️ pay as fear ⬆️ interest rate … workers suffer- same nominal wages (⬇️ in real terms)
2) 👎- ALSO firms ⬇️ likely to employ new workers- … ⬆️ difficult for unemployed to get work- potential loss of skills as a result of long-term unemployment

Question 22

Why does high demand lead to inflation?

Answer 22

Micro explanation- consumers bid up prices of good
Macro explanation- ⬆️ consumption and … AD (component of formula) means that ⬆️ 💵 is injected (circular flow of income) into the economy which increases the money supply … ⬆️ 💵 chasing same amount of 🚘 … prices ⬆️ and value of 💴 eroded