Inflation (Up Learn)

Question 1

Inflation

Answer 1

A sustained increase in the general price level. Average price of goods and services is rising. If uncontrolled, it leads to hyperinflation.

Question 2

Causes of Inflation

Answer 2

Demand-Pull and Cost-Push

Question 3

Demand-Pull

Answer 3

Shown on LRAS or Keynesian or SRAS. When the population is high, AD curve shifts to the right, the price level increases. When AD increases, it pulls up the price level which leads to inflation

Question 4

Cost-Push

Answer 4

When there are high costs, it shifts SRAS curve to the left, which pushes up the price level which leads to inflation.

Question 5

Hyperinflation

Answer 5

When inflation rate increases above 50%

Question 6

Deflation

Answer 6

A sustained decrease in the general price level. Stuff gets cheaper.

Question 7

Deflationary Spiral

Answer 7

The spiral begins with deflation which is where there is sustained fall in general price level. Consumers notice the falling prices and decide to delay their purchases and wait for prices to fall further. So there is a reduce is current consumption which reduces AD. The fall in AD lowers the price level again and so consumers further delay their purchases. And the cycle repeats.

Question 8

Effects of Deflationary Spiral

Answer 8

Real GDP decreases and unemployment increases as they had to fire workers.

Question 9

Causes of Deflation

Answer 9

Decrease in AD, Increase in AS

Question 10

Decrease in AD

Answer 10

Eg: if investment decreases = AD shifts to the left, price level decreases, which is deflation

Question 11

Increase in AS

Answer 11

A reduction in price causes a reduction in firms costs, causes firms to produce more, shifts SRAS/LRAS to the right and so price level falls.

Question 12

When can you only look at SRAS or LRAS curve?

Answer 12

When costs are changing

Question 13

What does a change in price level cause?

Answer 13

A change in value of money i.e. what our money is worth.

Question 14

Increase in price level: Inflation

Answer 14

Decrease in value of money as goods get more expensive and so you buy less with your money

Question 15

Decrease in price level: Deflation

Answer 15

Increase in value of money i.e. each £ gets us more of those goods as it is cheaper

Question 16

Nominal

Answer 16

How much you earn in pounds

Question 17

Real

Answer 17

How much your income is really worth

Question 18

High inflation and prices leads to…

Answer 18

Low real income (because inflation was removed)

Question 19

Real income in terms of nominal income

Answer 19

Nominal income minus effects of inflation

Question 20

Inflation rate

Answer 20

% change in price level

Question 21

How to calculate UK’s price level?

Answer 21

Stage 1 - ONS conducts its Living Costs and Food Survey. This involves interviewing 7000 households to find 650 most common goods and services and to find % of their spending that goes on each of these goods and services.
Stage 2 - ONS conducts price survey where they collect prices of these 650 goods from the basket across the UK to find the average price of each good.
Stage 3 - a weighted average of all the prices is calculated to find the price level. Then convert price level into CPI to make it easier to calculate rate of inflation.

Question 22

Disinflation

Answer 22

When inflation rate is positive but decreasing. Price level is increasing by less year by year

Question 23

Problems with CPI

Answer 23

Unusual spending habits, Time lag, Changes in quality, Doesn’t include mortgages.

Question 24

Unusual spending habits

Answer 24

Some people would spend differently to what the average consumer would get. What they spend wouldn’t be in the CPI basket. The unusual customer wouldn’t experience the same price changes as an average customer. Therefore it makes CPI inaccurate

Question 25

Time Lag

Answer 25

CPI is only updated once a year. Won’t include goods in the basket that have recently become popular so fails to measure changes in price level. The recently popular goods would only go in the basket 1 year later

Question 26

Changes in Quality

Answer 26

When prices increase, it isn’t because of inflation but it’s with a product that has got better quality: iphone 5 and iphone x. Prices increased because of changes in quality, not inflation.

Question 27

No Mortgages

Answer 27

Mortgages is when someone borrows money to buy a house so you have to pay regularly. When bank interests rise for example, the mortgages rise. People spend most of their income on mortgages.

Question 28

RPI

Answer 28

Similar to CPI, but includes mortgages. This is to see how mortgage payments are changing each year and give pensions to the elderly according to their mortgages.

Question 29

Benefits of High Inflation

Answer 29

Protects against deflation. Reduced debts (higher prices means money you owe is worth less so real value of debt decreases). Lower real wages meaning lower costs for firms and gov.

Question 30

Price Wage Spiral

Answer 30

High inflation, Higher prices, higher costs of living, demand for more wages to cover their costs of living, increases firm costs, SRAS curve would shift to the left and so price level increases.

Question 31

Cons of High Inflation

Answer 31

Price wage spiral which would lead to hyperinflation. Reduces real wages (real value decreases so real wage would fall, workers grow poorer). Makes investment more risky as you don’t know the future prices and costs which decreases investment.