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HSC Economics > Inflation: Basics > Flashcards

Inflation: Basics Flashcards

1
Q

What is inflation?

A

A rise in the general level of prices in an economy

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2
Q

How is inflation calculated?

A

[(CPI in Year 2 - CPI in Year 1) / CPI in Year 1] x 100

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3
Q

What is the CPI?

A

An index of changes in the price of a basket of goods and services, weighted by the proportion of household spending on each item

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4
Q

What is the difference between headline and underlying inflation?

A

Headline measures prices changes in all goods and services, whereas underlying removes the most volatile items (e.g. petrol, fruit)

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5
Q

How do you calculate real GDP?

A

(Nominal GDP / CPI) x 100

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6
Q

What are 4 causes of inflation?

A
  1. Demand
  2. Cost
  3. Imported
  4. Inflationary expectations
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7
Q

What is demand inflation?

A

An increase in aggregate demand causes customers to bid up the prices of scarce goods and services

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8
Q

What is cost inflation?

A

An increase in production costs causes firms to raise prices of goods and services

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9
Q

What is imported inflation?

A

An increase in prices of imported products leads to higher prices in the domestic economy

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10
Q

Why do inflationary expectations cause inflation?

A

If individuals expect high inflation, they will demand higher wage rises. These higher wages will increase firms’ costs, causing the expected inflation to actually occur.

Also, if firms expect inflation, they will raise prices ahead of the expected rise in input costs. Raising prices will cause the expected inflation to occur.

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11
Q

What are 5 costs of inflation?

A
  1. Reduced growth
  2. Reduced purchasing power
  3. Worse inequality
  4. Worse international competitiveness
  5. Higher interest rates
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12
Q

Why does inflation slow economic growth?

A

A number of reasons:

1) It reduces international competitiveness
2) Firms are less likely to spend on investment (e.g. expansion), because it is unclear if price rises are because their product is popular or just because of general inflation
3) Wage negotiations focus on ensuring wages keep up with inflation, rather than on rewarding improvements in labour productivity

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13
Q

What are 3 benefits of inflation?

A

1) Avoids risk of deflation

2) Potential for downward wage adjustments

3) Bracket creep

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14
Q

What is the RBA’s inflation target?

A

2-3% on average over the course of the business cycle

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15
Q

When did the RBA start inflation targeting?

A

1993

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16
Q

What have been the main trends in Australia’s inflation rate?

A

In general, has averaged between 2-3% since 1993.

Was below 2% for 6 years prior to the pandemic.

Fell significantly during the pandemic.

Spiked in 2022/3.

Has fallen in 2024

17
Q

Why did inflation fall in the pandemic?

A

1) Low consumption and private investment
2) Child care subsidy temporarily covered the full cost of child care

18
Q

Why didn’t inflation fall further in the pandemic?

A

1) Disruptions to shipping and labour increased firms’ costs
2) 2020 bushfires also increased price of food and timber
3) Expansionary macro policy, including unconventional monetary

19
Q

Why has inflation spiked so much in 2022?

A

1) Continued expansionary macro policies
2) Global supply chain disruptions (increased demand for goods and fewer plane flying means shipping costs up by over 700%)
3) Labour shortages
4) Russia sanctions increasing oil prices

20
Q

What are the 3 policies used to control inflation?

A

1) Monetary policy
2) Fiscal policy
3) Microeconomic reform

21
Q

What is the main policy used to control inflation?

A

Monetary policy

22
Q

If inflation is high, should the RBA raise or lower the cash rate?

A

Raise it

23
Q

If inflation is low, should the RBA raise or lower the cash rate?

A

Lower it

24
Q

If inflation is high, should the government tax more or less?

A

Tax more

25
Q

If inflation is low, should the government tax more or less?

A

Tax less

26
Q

If inflation is high, should the government spend more or less?

A

Spend less

27
Q

If inflation is low, should the government spend more or less?

A

Spend more

28
Q

How does microeconomic reform help to control inflation?

A

By improving competition and efficiency, firms will find ways to lower prices

HSC Economics (39 decks)

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