Inflation and deflation Flashcards
What are inflation, deflation, and disinflation?
Inflation is the general rise in price levels over time. Deflation is the general decrease in price levels. Disinflation refers to a reduction in the rate of inflation, meaning prices rise but at a slower pace.
What are demand-pull and cost-push inflation?
Demand-pull inflation occurs when aggregate demand exceeds aggregate supply, causing prices to rise. Cost-push inflation happens when production costs increase (e.g., higher wages or raw materials), leading firms to raise prices to maintain profit margins.
What is Fisher’s Equation of Exchange, and how does it relate to the Quantity Theory of Money?
Fisher’s Equation of Exchange, MV = PQ, states that the money supply (M) times its velocity (V) equals the price level (P) times output (Q). The Quantity Theory of Money suggests that if money supply grows faster than output, it will lead to inflation, as seen in monetarist models.
How do expectations affect the price level?
If individuals and businesses expect future inflation, they may demand higher wages or increase prices preemptively, which can lead to a self-fulfilling inflationary cycle. Likewise, expectations of deflation may cause consumers to delay purchases, reducing demand and further lowering prices.
What are the consequences of inflation for individuals and the economy?
For individuals, inflation reduces purchasing power and can erode savings. For the economy, it can lead to higher interest rates, uncertainty in investment, and reduced international competitiveness if domestic prices rise faster than those of trading partners.
What are the consequences of deflation for individuals and the economy?
Deflation can increase the real value of debt, discouraging borrowing and spending. For the economy, it may lead to reduced consumption, lower profits for firms, and higher unemployment as firms cut costs, potentially causing a deflationary spiral.
How do changes in world commodity prices affect domestic inflation?
Rising global commodity prices (e.g., oil, food) increase costs for businesses, which can lead to cost-push inflation domestically. Conversely, falling commodity prices can reduce inflation by lowering production costs.
How can changes in other economies affect inflation in the UK?
Economic growth in trading partners can raise demand for UK exports, increasing domestic demand-pull inflation. Conversely, a downturn in major economies may reduce UK exports, lowering inflationary pressure. Exchange rates also play a role: a weaker pound raises import prices, leading to higher domestic inflation.
