Inflation & Deflation

Question 1

Inflation

Answer 1

A persistent rise in the price level within an economy over a period of time.

Question 2

Deflation

Answer 2

When the price level in an economy falls over a period of time.

Question 3

Price level

Answer 3

The average price of goods and services in an economy

Question 4

Consumer price index

Answer 4

The UK government’s preferred price index for measuring the price level and inflation

Question 5

Rate of inflation

Answer 5

The rate at which the price level rises over a period of time.

Question 6

What is hyperinflation?

Answer 6

Large and rapid increase in the price level which undermine the value of money and discourage economic activity.

Question 7

Examples of hyperinflation

Answer 7

• Inflation rate exceeds 50% per month

• Associates with extreme political instability and war

Question 8

How do falling price affect consumption?

Answer 8

Falling prices discourage consumption.

Can save money by waiting for lower prices.

Question 9

Impacts of consumption due to inflation.

Answer 9

Rising & volatile inflation - Discourages

Modest, Steady, Consistent - Encourages

Low and risk of deflation - Discourages

Question 10

What does the CPI reflect?

Answer 10

The prices of a sample of goods and services weighted to reflect what the household expenditure survey estimates the average household spends its money on

Question 11

What are the benefits of inflation?

Answer 11

• Encourages consumption
• Incentivises production
• Reduces real wage costs
• Reduces debt burdens

Question 12

What are the costs of inflation?

Answer 12

• Reduces confidence
• Shoe leather costs
• Menu costs
• Real values
• Competitiveness
• Fiscal drag
• Income re-distribution

Question 13

What is shoe leather costs?

Answer 13

Research costs

Question 14

What is a menu cost?

Answer 14

Firms will need to adjust prices more frequently if the rate of inflation is high. = transaction cost.

Question 15

What is fiscal drag?

Answer 15

• Incomes rise in line with inflation

• Tax thresholds remain fixed

• Real earnings remain the same

• Tax deductions increase

• Real disposable income falls

• Real consumption reduces

Question 16

What is money illusion?

Answer 16

Wages rise, but so does inflation at a higher rate.

Consumers think they are better off due to increased wages when in reality their purchasing power has decreased.

4% wage rise. 5% inflation.

Question 17

How does income re-distribution effect borrowers and savers due to inflation?

Answer 17

Borrowers:
- Better off, reduced debt burden

Savers:
- Worse off, real values fall

Question 18

How does income re-distribution effect Non-workers and Workers due to inflation?

Answer 18

Non-workers:
- Recipients of transfer payments receive protection from inflation

Workers:
- Real Value of Assets?
- Burden of Debt?
- Real Wages?