Inflation and Deflation

Question 1

What is inflation?

Answer 1

The sustained rise in the general price level over time. This means that the cost of living increases and the purchasing power of money decreases

Question 2

What is deflation?

Answer 2

Where the price level in an economy falls, i.e there is negative inflation.

Question 3

What is price level?

Answer 3

The average of current prices across the entire spectrum of goods and services produced in an aconomy

Question 4

What is disinflation?

Answer 4

The falling rate of inflation. This means the average price level is still rising, just to a slower extent. This means that goods and services are relatively cheaper than a year ago

Question 5

What is the aim of deflationary policies?

Answer 5

To reduce aggregate demand

Question 6

What is demand pull inflation?

Answer 6

When aggregate demand is growing unsustainably so there is pressure on resources and producers increase their prices. This usually occurs when resources are fully emplo

Question 7

What are the triggers for demand pull inflation?

Answer 7

• A depreciation in the exchange rate
• Fiscal stimulus
• Lower interest rates
• High growth in UK export markets

Question 8

How does a depreciation in the exchange rate trigger demand pull inflation?

Answer 8

This causes imports to become more expensive whilst exports become cheaper, causing AD to rise

Question 9

How does a fiscal stimulus trigger demand pull inflation?

Answer 9

Fiscal stimulus in the form of lower taxes or more government spending means consumers have more disposable income and therefore consumer spending increases

Question 10

How do lower interest rates trigger demand pull inflation?

Answer 10

Lower interest rates make saving less attractive and borrowing more attractive, so consumer spending increases

Question 11

How does growth in UK export markets trigger demand pull inflation?

Answer 11

High growth means UK exports increase and therefore AD also increases

Question 12

What is cost push inflation?

Answer 12

When firms face rising costs so increases their prices

Question 13

What are the possible causes of cost push inflation?

Answer 13

• Changes in prices of goods
• Labour becoming more expensive
• Expectations of inflation
• Indirect taxes
• Depreciation in the exchange rate
• Monopolies

Question 14

How do changes in the price of goods cause cost push inflation?

Answer 14

When the world price of goods increase this can make raw materials more expensive and increase the cost of production

Question 15

How does changes in the price of labour cause cost push inflation?

Answer 15

Labour becoming more expensive (for example due to trade unions) means that the cost of production increases

Question 16

How does the expectation of inflation cause cost push inflation?

Answer 16

If consumers expect prices to rise then they may ask for higher wages, triggering more inflation

Question 17

How do indirect taxes cause cost push inflation?

Answer 17

If producers choose to pass the costs onto customers then taxes on goods can cause inflation

Question 18

How does depreciation in the exchange rate cause cost push inflation?

Answer 18

Imports become move expensive, pushing up raw material prices

Question 19

How can monopolies can cost push inflation?

Answer 19

They may use their dominant market position to exploit consumers with high prices

Question 20

What are the effects of inflation on consumers on low/fixed incomes?

Answer 20

Those on lower or fixed incomes are hit hardest due to inflations regressive effect as the price of essential goods increases

Question 21

How does inflation affect consumer loans?

Answer 21

Loan repayments will be lower as owed debt does not increase with inflation, meaning the real value of debt decreases

Question 22

How does inflation affect interest rates and investment?

Answer 22

As high inflation increases, interest rates also increases meaning the cost of investment will be higher. This results in a reduction in investment.

Question 23

How does inflation affect wages?

Answer 23

Workers may demand higher wages, increasing the cost of production for firms

Question 24

How does inflation affect a firms price competetiveness?

Answer 24

If inflation is high then firms may be unable to compete on global markets. However, this is reliant on how other countries are performing.

Question 25

What is the effect of unpredictable inflation?

Answer 25

Unpredictable inflation reduces business confidence, reducing investment.

Question 26

How does inflation affect government finances?

Answer 26

The government will have to spend more on state pensions and welfare pensions because the cost of living is increasing

Question 27

What are the effects of deflation on the real value of money?

Answer 27

The real value of money will increase

Question 28

What are the effects of deflation on the real value of money?

Answer 28

The real value of money will increase

Question 29

What are the effects of deflation on the real value of debt?

Answer 29

It makes the real value of debt higher so people in large amounts of debt will be spending a high proportion of their income on repayments

Question 30

What are the effects of deflation on consumer spending?

Answer 30

It discourages spending as it means goods and services will be cheaper in the future

Question 31

What are the effects of deflation on economic growth?

Answer 31

It results in economic decline and stagnation as consumers have less disposable income and therefore the level of spending will decrease

Question 32

What is the Quantity Theorem of Money?

Answer 32

If the money supply increases at a faster rate than national income there is inflation