inflation and deflation

Question 1

define Inflation

Answer 1

sustained rise in the level of prices of goods and services in an economy over a period of time.

Question 2

how is Inflation and deflation measured? (5)

Answer 2

• measured using a consumer price index (CPI)
• A selection of goods and services normally purchased by a family or household is identified.
• The prices of these ‘basket of goods and services’ will then be monitored at a number
• The average price of the basket in the base year is given a value of 100.
• The average change in price of these goods and services over the year is calculated.

Question 3

define consumer price index (CPI)

Answer 3

a measure of the weighted average of the price of a representative basket of goods and services.

Question 4

Causes of Inflation (3)

Answer 4

1. Demand-pull inflation: inflation caused by an increase in aggregate demand is called demand-pull inflation.
2. Cost-push inflation: caused by an increase in cost of production in the economy
3. a rise in money supply in contrast with output is the key reason for inflation: If the GDP isn’t accelerating as much as the money supply, then there will be a higher demand which could exceed supply, leading to inflation.

Question 5

define cost puch inflation

Answer 5

rises in the price level
caused by higher costs
of production.

Question 6

define Demand-pull
inflation

Answer 6

rises in the
price level caused by
excess demand.

Question 7

define Wage-price spiral

Answer 7

wage rises leading to higher prices which, in turn, lead to further wage claims and price rises.

Question 7

The consequences of inflation? (3)

Answer 7

1. Lower purchasing power - when the price level rises, the lesser number of goods and services you can buy ,in this situation Hyperinflation may occer.
   2.Exports are less internationally competitive - if the prices of exports are high, its competitiveness in international markets will fall . This could lead to a current account deficit if exports lower (especially if they are price elastic).
2. Inflation causing inflation: the cost of living in the economy rises. This might cause workers to demand higher wages increasing the cost of production. If the price of raw materials also increase , the cost of production again increases, causing cost-push inflation.
3. Fixed income groups, lenders, and savers lose
   * a person who has a fixed income will lose as he cannot press for higher wages during inflation
   * Lenders who lent money before inflation and receive the money back during inflation will lose the value on their money.
   * Savers also lose because the interest they’re earning on savings in banks does not increase as much as the inflation

Question 7

define Monetarists

Answer 7

a group of economists who think that inflation is caused by the money
supply growing more rapidly than output.

Question 8

define Monetary inflation

Answer 8

rises in the price level caused by an excessive growth of the money supply.

Question 9

define hyperinflation

Answer 9

a
very rapid and large
rise in the price level.

Question 10

Policies to control inflation (4)

Answer 10

1. Contractionary monetary policy - Raising interest rates will discourage spending and investing and reduce the money supply in the economy, helping cut down on demand
2. Contractionary fiscal policy - raising taxes will discourage spending and investing this will reduce aggregate demand , helping bring down the price level.
3. Supply side policies - privatisation and deregulation hope to make firms competitive and efficient, and thus avoid inflationary pressures.
4. Exchange rate policy - ting the domestic currency can lower import prices helping reduce cost-push inflation arising from expensive imported raw materials

Question 11

benefits of Inflation (3)

Answer 11

1. may encourage firms to expand.
2. Inflation reduces the burden of debt that households and firms have built up, thus avoids going bankrupt.
3. Inflation can prevent some workers being made redundant in a declining industry, workers are likely to resist any cut in their money wages, they may accept their money wages rising by less than inflation. In

Question 12

Causes of deflation (4)

Answer 12

• Aggregate supply exceeding aggregate demand: when supply exceeds demand, there is an excess of output in the economy not consumed, causing prices to fall.
• Demand has fallen in the economy: during a recession, a fall in demand in the economy causes general prices to fall and cause a deflation.
• Labour productivity has risen: higher output will lead to lower average costs, which could reflect as lower prices for products.
• Technological advance has reduced cost of production, pulling down cost-push inflation.

Question 12

define Deflation

Answer 12

general fall in the price level.

Question 12

Consequences of deflation

Answer 12

• Lower prices will discourage production, resulting in unemployment.
• As demand and prices fall, investors will be discouraged to invest, lowering the output/GDP.
• Deflation can cause recession as demand and prices continue to fall and firms are forced to close down as enough profits are not being made.
• Tax revenue of the government will fall as economic activity and incomes falls. They might be forced to borrow money to finance public expenditure.
• Borrowers will lose during a deflation because now the value of the debt they owe is higher than when they borrowed the money.
• Deflation will **increase the real debt burden of the government **as the value of debt money increases.

Question 13

Policies to control deflation

Answer 13

1. Expansionary monetary policy - cutting interest rates will encourage more spending and investment in the economy which will stimulate prices to rise.
2. Expansionary fiscal policy - increasing government spending in the economy, especially in infrastructure will help raise demand, along with cuts in direct taxes.
3. Devaluation - devaluing the currency through selling domestic currency and/or increasing the money supply will cause export prices to fall, encouraging production of exports, resulting in higher demand; and also increase prices of imported products which will raise costs and prices for products in the economy.
4. Change inflation expectations - businesses won’t increase wages and consumers won’t pay higher prices, higher inflation, firms will pay their workers more and consumer will spend more now, avoiding a deflation.