Inflation And Deflation Flashcards
Define inflation
Sustained increase in general price level of an economy
What is meant by galloping inflation
High inflation at double/triple digits
What are the 2 kinds of inflation
- Demand pull
- Cost push
Define demand-pull inflation, describe how this is shown in an ADAS diagram
- sustained increase in general price levels caused by persistent rises in aggregate demand
- continuous shift of AD to the right
Is demand-pull inflation caused by GPL or non-GPL factors, and does it cause an increase in autonomous or induced consumption?
Non-GPL, autonomous
- autonomous consumption, investment, government expenditure, autonomous net exports
Explain how an increase in AD causes demand-pull inflation (referencing ADAS diagram) (approx 9 steps)
- Increase in AD -> rightward shift of AD from AD0 to AD1
- Assuming economy initially at equilibrium AND operating at intermediate range of AS curve
- Total planned expenditure is more than total planned output
- Shortages where all output is sold but not all demand is met
- Unplanned disinvestment
- Stock levels fall below optimal
- Firms increase production in the next cycle, employ more FOPs
- Firms pay out more factor income due to higher competition for scarce resources (labour)
- Each additional unit of output becomes more expensive to produce, firms have to increase prices to remain profitable
- Increase in GPL from P0 to P1
What determines the “slack” or extent of GPL increase in the next production cycle
- amount of spare capacity available
Wha are the sources of cost push inflation, what do they all increase that affect AS
- Inflation due to exhaustion of raw materials
- Import induced inflation
- Wage push inflation - wage increases that are GREATER than increase in productivity
- Profits push inflation — evident in monopolies who have control over price (price setters)
- Tax push inflation (GST)
- cost of production
What are the 6 benefits of a low and stable inflation rate
- Promotes investment and economic growth — AS — potential economic growth
- Promotes international competitiveness and improves BOT and BOP — domestic vs foreign inflation
- Promotes sustained economic growth and lower unemployment
- Maintain current and future standard of living (without compromising either) - workers can ensure nominal wage rate increments at least keeps up with inflation
- Improve efficiency in resource allocation
- Increases leeway for monetary policy -> central bank can lower nominal interest rate with leeway to stimulate more spending
How does a lower domestic inflation improve BOT (7 steps, both X and M)
- lower domestic inflation than foreign inflation
- price of domestic country exports cheaper and more competitive
- foreign countries increase demand for cheaper exports
- raising export revenue
- domestic households demand less expensive imports
- substitute with domestically produced substitutes
- reduces import expenditure
How does lower domestic inflation improve BOP position
- greater economic certainty —> FDI increases and hot money -> capital/financial account position improves
How does low and stable inflation promote sustainable growth and lower unemployment
- healthy level of consumption -> increase in AD
- multiplier effect — demand for labour as derived demand increases -> cyclical unemployment decreases
How does low and stable inflation rate improve efficiency in resource allocation (what function of price does it have on output decisions, how does it impact both allocative and productive efficiency)
- signalling function of price
- increased price -> increased demand -> producers produce more to meet demand -> allocative efficiency
- increased investment -> productive efficiency as resources not channeled to other sources such as property and equities to oppose inflation
What are the costs of high and unstable inflation? (8)
- More difficult to protect material standard of living - nominal incomes do not keep pace with increase in price
- Reduced investment which hinders economic growth
- Reduced international competitiveness and worsens BOP
- Difficulty in sustaining economic growth - surge in speculative activity, fall in I and X -> AD decrease
- Arbitrary redistribution of income — those well protected benefit more than the layman (e.g. gold holders, variable income through dividends and assets, debtors vs creditors - more worse off)
- Menu costs (intermediate costs that drive up final price of goods further)
- Hinders efficient resource allocation — difficult to distinguish change in specific price of product to change in overall GPL - misread as increased demand and incurs unwanted production
- Hyperinflation (wage price spiral)
What is the difference between deflation and disinflation
Deflation: sustained decrease in GPL
Disinflation: slowing down of inflation, GPL increases art a slower rate
What are the 2 categories of causes of deflation
AD
AS
How does AS cause deflation (link from event causing COP to change)
Lower COP -> increase in AS (shift down) -> deflation (beneficial)
How is deflation good (2 reasons)
- Increases purchasing power
- Due to firms and workers being more productive
Why is deflation undesirable (3)
- Deflationary spiral
- Increase real burden of debts
- Harder to solve than inflation
Describe the deflationary spiral
- Households/firms expect prices to fall in the future
- Hold back their purchases/investment
- Fall in autonomous consumption
- Leftward shift of AD
- Demand-deficient unemployment rises (labour as derived demand)
- MTP decrease in RNY due to multiplier
Why is deflation harder to solve than inflation
- to combat deflation, interest rates need to be cut to induce spending and drive up prices
- cannot be cut further if inflation is at 0 or negative (as is the case already with deflation)
