INFLATION REVISION

Question 1

What is inflation ?

Answer 1

A sustained increase in the cost of living / the general price level leading to a fall in the purchasing power of money

Question 2

What are some limitations of the CPI ?

Answer 2

Changes in price may be due to changes in the quality of the product

CPI is slow to react to new products

Published figure is never the actual figure experienced by different people

Single people have different spending patterns than families

Question 3

What are the main causes of inflation ?

Answer 3

Demand pull inflation
Cost push inflation
Administered prices

Question 4

What is demand pull inflation ?

Answer 4

Caused by excess AD
Economy is close to full capacity
When there is too much demand against the supply
So stores will increase prices due to its scarcity

Question 5

What is cost push inflation ?

Answer 5

When overall prices increase due to increases in the cost of production

Increased demand for higher wages and raw materials increase the cost of production , so suppliers increase prices to cover costs

Question 6

What is Administered prices ?

Answer 6

When the GOVT changes regulation prices , indirect taxes / subsidies .

Question 7

What are some factors that affect inflationary pressures ?

Answer 7

Rising property prices increases consumer wealth causing demand pull inflation

Increases in global oil prices increases costs for businesses causing cost push inflation

Depreciation of exchange rates increase import prices and increases exports . Cost + demand pull inflation risks

Rapid expansion of credit from banks increases consumer spending which causes demand pull inflation

Question 8

Explain demand pull inflation using an AD and AS curve

Answer 8

Demand pull inflation occurs when AD in increasing unsustainably .
Where there is excess demand , producers increase prices / bigger PM’s . More likely to happen in full employment

On the diagram we would see AD expanding to the right

Question 9

Explain a cost push using an AD and AS curve

Answer 9

Cost push inflation occurs when firms respond to rising costs by increasing their prices to protect profit margins caused by :

Rising unit labour costs
Increased Raw material cost / component cost
Depreciation in exchange rates / increasing import costs
Increases in business taxes

On the diagram we would see the AS curve shifting inwards ( to the left )

Question 10

What are some internal causes of inflation ?

Answer 10

Large surges in property prices
Higher wage / labour costs
Rise in business taxes
Boom in credit

Question 11

What are some external causes of inflation ?

Answer 11

Increase in world oil prices
Inflation in world commodity prices
Inflation in other countries
Depreciation in exchange rates

Question 12

Why is high inflation an economic problem ?

Answer 12

Interest rates on savers is lower than inflation
High inflation causes high interest rates for people with debts
Rising labour costs and lower profits
Reduces competitiveness - lowers demand for countries exports
Has a regressive effect on low income families

Question 13

Who may be a winner due to high inflation ?

Answer 13

Workers with high wage bargaining power

Producers if price rises further than costs

Question 14

Who may be the losers during a time of high inflation ?

Answer 14

Retired people on fixed incomes
Lenders id real interest rates are -
Savers if real returns are -
Workers in low paid jobs

Question 15

What are some factors that may impact the reliability of the data you receive about inflation ?

Answer 15

Fiscal policy - includes less spending on public / merit goods or welfare payments or raising direct taxes

Monetary policy - Via higher interest rates or reversal of quantitative easing / tougher control on bank lending

Supply side policies - To increase productivity , competition , innovation

Question 16

What is quantitative easing ?

Answer 16

The central bank buys assets such as bonds - by doing so they inject new money into the economy - This provides more liquidity to banks - the goal is the encourage lending and investment by lowering I rates further

Question 17

What is deflation ?

Answer 17

A persistent fall in the GPL of goods and services . The rate of inflation becomes negative

Question 18

What is Disinflation ?

Answer 18

When there is a fall in the rate of inflation - there is still positive inflation rates but less than the previous month

Question 19

What are some demand side causes of deflation ?

Answer 19

Deep falls in AD causing a persistent recession
Large negative output gap

Question 20

What are the supply side causes of deflation ?

Answer 20

Improvements in productivity
Technological advances
Fall in wage rates
High exchange rates causing import prices to fall

Question 21

What are the consequences of Deflation ?

Answer 21

People postpone spending if they expect prices to fall in the future

Real value of debts increase - lower consumer confidence

Falling asset prices - hits personal wealth

Debtors may default - redistribution of wealth from debtors and creditors

Competitive exports comes at a cost of higher unemployment

Question 22

What are some economic policies to avoid price deflation

Answer 22

Low I rates + quantitative easing ( cheaper loans for businesses + homes , expanding of credit supply )

Fiscal stimulus measures ( Higher GOVT spending , Rise in GOVT borrowing to inject demand into CFI , lower taxes to increase disposable income )

Other measures to stimulate aggregate demand ( attempts to lower the value of exchange rates , Higher taxes on savings to encourage consumption )