Inflation flashcards
What’s inflation?
A continuing rise in prices OVER A PERIOD OF TIME!!!!
What’s aggregate demand?
The total demand for all expenditures in the econonmy
What’s deflation?
Aggregate demand falls, inflation is negative and prices decrease
What’s disinflation?
Inflation is positive but falling slowly, disinflation causes prises to rise and the value of money to fall
What’s CPI?
Measure of the general price level excluding housing costs from the same price info monthly
CPI uses a shopping basket
How to calculate CPI?
The cost of basket in year X / The cost of basket in base year x 100
Percentage diff between CPI of 2 years:
final CPI - initial CPI/initial CPI x 100
What are the two types of inflation?
Demand Pull inflation
Cost Push inflation
What’s demand pull inflation?
Inflation caused by excess demand in the ecoonmy relative to supply
If demand increases, price increases
What are causes of demand pull inflation?
- Rising consumer spending due to tax cuts or low interest rates
- Sharp increases in gov spending
- Rising demand for resources by firms
- Booming demand for exports
What’s cost push inflation?
When businesses push the costs to the consumers in an economy
When businesses are faced with rising costs, they put up their prices to protect their profit margins and inflation gets cauased
What are causes of cost push inflation?
Rising costs of imported goods like oil
Wage increases - Trade unions put pressure on employers to increase wages and employers recover the extra money to pay to the workers by increasing prices
Increase in tax
If entrepreneurs try to increase the amount of profit
How might interest rates affect inflation?
Governments raise interest rates to decrease the rate of inflation
If interest rates rise, borrowing will fall as it becomes more expensive and the money supply falls hence, demand falls resulting in decreased inflationary pressure
Impact of inflation on prices?
As prices rise, inflation reduces the purchasing power of money meaning people can’t buy as much with their income and living standards decreases
Impact of inflation on wages
As prices rise, workers need to increase wages to compensate for the loss in purchasing power. Wages may need to rise to keep up with inflation as real wages fall
As a result of higher wages, firms increase their prices due to THEIR costs rising and if this pattern repeats, a wage spiral develops; higher prices lead to even higher prices hence, inflation gets caused.
Demand for higher wages during inflation causes conflict between employers and trade unions causing a strike hence, a loss for both the workers and the firms.
Impact of inflation on exports
As prices increase domestically more than in other countries, firms may find it difficult to sell in overseas markets due to rising prices of exports hence, demand for exports falls and the balance of payments is affected negatively.
Impact of inflation on unemployment
- As inflation decreases, prices decrease and aggregate demand rises resulting in firms being keen to increase output and them wanting to recruit more workers which reduces unemployment
- It’s important to note that the government can use monetary and fiscal policy tools to manage the level of inflation without necessarily causing high levels of unemployment
Impact of inflation on Menu Costs
As prices increase, firms will have to tell customers which will cost money due to advertisement costs like new brochures being made and sales staff would need to be informed falling into the menu costs
These are called menu costs as for a restaurant a new menu has to be printed when prices increase.
Impact of inflation on Shoe Leather Costs
As prices rise, costs to firms and consumers of searching for new suppliers for the best deals rise too hence, opportunity costs are also incurred as time is wasted whilst doing so
Impact of inflation on uncertainty
As prices rise, firms don’t know what prices will be in the future and planning for the future becomes impossible
Decisions will have to be made on the spot which will affect businesses in the long term
Impact of inflation on Business & Consumer confidence?
As prices rise, the uncertainty rises too which has an affect on the confidence of businesses and consumers.
High prices make consumers anxious and cautious with their spending leading them to save more which reduces demand
High prices make businesses anxious as they may postpone growth plans or become cautious with spending on r&d hence, lack of confidence leads to less risk taking and economic growth decreases.
Impact of inflation on investment
As prices rise, uncertainty about future prices does too hence, investment projects become postponed or cancelled leading to negative economic growth and negative future level of employment in the economy
What do the effects of inflation depend on?
- The cause of the inflation
- The rate of the inflation
- Whether the rate is accelerating or stable
- Whether the rate was expected
- How the rate compares with other countries
Which is more harmful, Demand pull or cost push?
Demand pull is less harmful as it shows increasing output by a firm
If there’s high levels of uncertainty about the future, it will cause the most negative consequences like not being able to effectively plan
impact of inflation on savings
as prices rise, The real value of savings falls due to inflation and as purchasing power of money falls, consumers can only buy a few goods
What’s menu costs?
the costs incurred by a business when it changes the prices it offers to its customers
A classic example is a restaurant that has to physically print new menus when it changes the prices of its dishes
What’s shoe leather costs?
the time and effort people take to minimize the effect of inflation by searching for the best deals from suppliers hence, an opportunity cost is incurred as time is wasted.
