Inflation (CH 19)

Question 1

Define Inflation

Answer 1

Rise in general levels of prices and a fall in purchasing power of money

Question 2

Define Deflation

Answer 2

Fall in general levels of prices and a rise in purchasing power of money

Question 3

Define Disinflation

Answer 3

When inflation falls

Question 4

What does CPI stand for?

Answer 4

Consumer Price Index

Question 5

What is CPI used for?

Answer 5

• Measures households purchasing power with family expenditure surveys
• Surveys find out what consumers spend their income on
• From this a ‘bask of goods’ is created
• Goods are weighted according to how much income is spent on each item

Question 6

Key CPI points

Answer 6

• Survey is used
• Weighted basket of goods
• Measures average price changes of goods
• Updated annually

Question 7

Limitations of CPI measuring inflation

Answer 7

• Represents average household and not accurate for every individual one
• Different demographics have different spending patterns
• Slow to respond to new G/S even though update regularly

Question 8

What does RPI stand for?

Answer 8

Retail Price Index

Question 9

What is RPI used for?

Answer 9

Includes housing costs:
- Payments on mortgage interest
- Council tax

Question 10

What two components measure inflation in the UK?

Answer 10

CPI + RPI

Question 11

Define Real and Nominal values

Answer 11

Real- Shows actual quantity changes, modifies inflation

Nominal- Using current prices without modifying for inflation

Question 12

Causes of Inflation

Answer 12

• Demand pull
• Cost push

Question 13

Define Demand pull and the causes of it

Answer 13

When AD grows unsustainably, pressure on resources

Causes:
> Depreciation of exchange rates:
- Import expensive + Exports cheaper. AD rises
- High growth in the UK export market
- Low interest rates, increase in consumer spending

Question 14

Define Cost-Push and causes of it

Answer 14

When firms face rising costs

Causes:
- Labour become expensive
> Expectations of inflation:
- Consumer expect prices to rise, may ask for higher wages to make up for this, which can trigger increase of inflation

Question 15

Impact of Inflation on firms

Answer 15

• Interest rates rise (cost of investing higher which discourages firms to invest)
• Workers demand higher wages (cost of production rises)
• Less price competitive on global scale
• Reduces firms confidence, since not aware of what costs will be. Less investment

Question 16

Impact of Inflation on individuals

Answer 16

Workers:
- Increased redundancies/unemployment
- Less disposable income as real incomes falls with inflation

Consumers:
- Purchasing power of money falls
(If consumers have loans, value of repayment will be lower as amount owed doesn’t increase with inflation. so real value of debt increases)