lesson 14- inflation Flashcards
what is inflation
a general rise in prices
-where prices overall in an economy have risen from one year to the next
what is inflation rate
how much prices have risen by
what is creeping inflation
small increases in a price level over a sustained period
-governments aim for
what is hyperinflation
extreme example
rapid increases in price levels
-e.g. Zimbabwe 2008- 500,000,000,000% inflation due to printing money
what is deflation
a fall in the price level of an economy
what is disinflation
inflation rate falling
-not necessarily negative
what is stagflation
when inflation is rising or high when the economy is in recession
-caused by supply side shocks e.g. spike in oil prices, and poor economic policies e.g. interest rates too low
what is the consumer price index
-one positive element of it
a ‘‘basket of 700 goods’’ that are commonly bought is totalled up each month
-around 180,000 prices are collected
-this is then compared to the same prices a year ago, the %change is inflation rate
+=basket changes to account for changes in fashion/trends etc
what is the retail price index (RPI)
takes into account additional housing costs
the inflation basket is ____ to represent what consumers spend their money on
weighted
-e.g. things such as food are more commonly bought, so are given a higher proportion of the basket, so a change in price of food affects the measured inflation more than things such as tobacco, which have a lower ‘weight’
what is cost push inflation
cost of production increases, so SRAS decreases and price increases
-due to commodity prices, wages etc increasing
what is demand pull inflation
demand increases, so AD increases, and price increases
-due to increase in CIGXM, common when at full capacity
how do world commodity prices affect inflation
major cause of cost push inflation
-we need to import, so a increase increases cost of production, decreasing SRAS, and boosting prices
what are the costs of high inflation:
-growth and unemployment
-competitiveness
-redistribution costs
-psychological and political costs
-shoe leather costs
-menu costs
-hard to predict or plan, so investment decreases as risky, consumers may buy or postpone buying goods if they think inflation will further rise, disrupting patterns of spending- hard to supply
-exports decrease, imports are more competitive
-inflation can redistribute wealth between households, firms and the state, as some people have fixed incomes
-people feel they are worse off
-consumers and firms are less clear of what is a reasonable price, so they ‘‘shop around’’ which is a cost itself
-menu prices change -> more incurred costs
what is inflation psychology
if consumers or firms expect inflation to rise, they will buy goods and services.
-this is a inflationary buying behavior
-vice versa
what is the monetarist theory of inflation
monetarists (Milton friedman) believe that the general price level rises only due to an increase in the supply of money, but not proportionately
-they believe that monetary policy is effective (interest rates, quantitative easing)
-they argue that excess AD is caused by prior increase in the money supply
'’inflation is always and everywhere a monetary phenomenon’’
what does the quantity theory of inflation suggest
what is the fisher equation
there is a direct link between money supply and inflation
money supply x velocity of circulation of money= price level x quantity of output
MV=PQ
P=MV/Q
-people say that V and q barely change/don’t change enough to impact P, therefore M is the only thing influencing price
-more money chasing the same quantity of goods means prices will rise to compensate
-P and V will change in a recession
draw a value of money vs quantity of money vs price level graph, with an increase in money supply
http://img.sparknotes.com/figures/B/ba894028a7bf3442cf3026d32d6b7aac/msmd2.gif
The intersection of the money supply curve and the money demand curve shows both the equilibrium value of money as well as the equilibrium price level.
when do people benefit from inflation
if their wage rise is greater than inflation rate
why is:
-price stability (2%
inflation)
-small rates of inflation
good for firms
-allows them to plan
-firms can raise prices- good for business confidence
what does deflation cause
confidence in the economy suffers-> instability, a negative wealth effect, and slower growth in the long term
