Inflation and Deflation

Question 1

CPI

Answer 1

household expenditure survey - this seeks to measure what people spend their money on. This results in the 1000 most popular goods and surveys.

Weighting of different goods: the goods and services in the inflation index are given on weighting depending on what % of spending they generate.

price changes: every month changes in the p or G+S change. The p changes are multiplied by their weighting and continued into a single index figure that shares a % change/

Question 2

Problems with calculating CPI

Answer 2

The expenditure survey does not induce everybody eg pensioners are excluded but they have different spending changes such as heating

Changes in quality, computers have many more features than 10 years ago so it is difficult to compare prices because they are different goods

CPI ignores housing costs

It is impossible to measure all prices in the economy

Question 3

RPI

Answer 3

The RPI is like CPI but includes more factors like the cost of mortgage interest payments

Question 4

Core inflation

Answer 4

Core inflation measures the underlying rate of inflation, excluding volatile factors like raw material prices and taxes

a rise in oil prices could cause higher CPI inflation but the core inflation would be more stable

Question 5

Effects of inflation (consumers, firms, the economy)

Answer 5

Consumers: fall in the value of savings
fall in the value of debt - this makes it easier for consumers to pay back their debt
fall in real wages - low disposable income

Firms: Uncertainty - they may be less willing to invest and this can reduce the rate of economic growth

firms have to adjust price lists

the economy: less investment, leading to low economic growth

decline in competitiveness - leading to lower exports an deterioration in the current account which may lead to a depreciation

higher interest rates - governments may be concerned about inflation because of the uncertainty and potential living standards. Higher interst rates can reduce inflation but at the cost of lower economic growth

Question 6

Problems of deflation

Answer 6

less speding, reduces AD

higher real debt burden

monetary policy becomes ineffective - real interest rates may increase

real wage unemployment - if prices fall, but wages stay the same - it will case real wage unemployment

Question 7

Causes of deflation

Answer 7

Falling AD - this will lead to lower prices and lower wages

rising productivity - if deflation is caused by a fall in costs and rising productivity, then deflation may not be damaging to the economy

Question 8

What is demand pull inflation?

Answer 8

As the economy reaches full capacity, rising AD leads to more inflation could occur due to various factors such as:

• lower interest rates which reduces the cost or borrowing, encouraging spending and investment
• rising house prices which increases conumers wealth and confidence
• boom in export frm a rising global demand
• income tax cut, which gives consumers more disposable income to spend
• a rapid rise in the money supply

Question 9

What is cost-push inflation?

Answer 9

This occurs when there is a rise in the costs of firms, leading to short run AS shifting to the left. This could occur due to

• rising oil prices/raw material prices: this would increase the costs of most firms, due to hgher transport costs
• rising wages: if wages are pushed higher by trade unions, this will increase costs for firms
• import prices: 1/3 of all goods, if there is a depreciation in the exchange rate then import prices will become expensive. Leading to an increase in inflation.

Question 10

Effect of a devaluation on inflation

Answer 10

Higher AD - cheaper exports increase export demand, more expensive impro