INFLATION REVISION Flashcards
What is inflation ?
A sustained increase in the cost of living / the general price level leading to a fall in the purchasing power of money
What are some limitations of the CPI ?
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
What are the main causes of inflation ?
Demand pull inflation
Cost push inflation
Administered prices
What is demand pull inflation ?
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
What is cost push inflation ?
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
What is Administered prices ?
When the GOVT changes regulation prices , indirect taxes / subsidies .
What are some factors that affect inflationary pressures ?
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
Explain demand pull inflation using an AD and AS curve
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
Explain a cost push using an AD and AS curve
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 )
What are some internal causes of inflation ?
Large surges in property prices
Higher wage / labour costs
Rise in business taxes
Boom in credit
What are some external causes of inflation ?
Increase in world oil prices
Inflation in world commodity prices
Inflation in other countries
Depreciation in exchange rates
Why is high inflation an economic problem ?
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
Who may be a winner due to high inflation ?
Workers with high wage bargaining power
Producers if price rises further than costs
Who may be the losers during a time of high inflation ?
Retired people on fixed incomes
Lenders id real interest rates are -
Savers if real returns are -
Workers in low paid jobs
What are some factors that may impact the reliability of the data you receive about inflation ?
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
What is quantitative easing ?
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
What is deflation ?
A persistent fall in the GPL of goods and services . The rate of inflation becomes negative
What is Disinflation ?
When there is a fall in the rate of inflation - there is still positive inflation rates but less than the previous month
What are some demand side causes of deflation ?
Deep falls in AD causing a persistent recession
Large negative output gap
What are the supply side causes of deflation ?
Improvements in productivity
Technological advances
Fall in wage rates
High exchange rates causing import prices to fall
What are the consequences of Deflation ?
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
What are some economic policies to avoid price deflation
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 )
