lesson 18: inflation and deflation Flashcards
what is deflation?
an increase in the general price level
increase in the value of money
when do we have social breakdown?
hyper inflation
what is the effect of setting a max price?
it distorts the market
where does all types inflation have its root cost it?
rising costs
only question is why is the costs rising
if price of oil rises then…
all costs increase
when is inflation not an issue?
if wages rise too
or we get the wage squeeze
what does a fall in price do to businesses?
shatters business confidence
what are four effects of deflation?
decrease in investment
buyers strikes
value of money is increasing then value of debt does too so increase in debt trap
hard to get rid of
deflationary spiral
malign deflation
bad
decrease in AD
what is the wealth effect?
increase house prices/ assets
increases confidence
increases consumption
increases AD
what is the fisher equation and what does it show?
(total spent) MV=PQ (total produced) —> M=P
directly proportional relationship
all money spent is the value of everything bought
what does the quantity theory of money argue?
we get inflation because of too much money (supply) chasing too few goods
what is the monetarist view of inflation?
too much money supply leads to inflation
what is the keynsians view of reverse causation?
we need more money when prices increase
inflation is caused by cost push factors in the real economy
why do we have to borrow during a deep recession?
we borrow to stimulate since we have spare capacity and this increases AD
what are wage push theories?
strong trade unions negotiate wages increases in excess of any rise in productivity
monopoly firms pay the wages to avoid production disruptions
these higher costs can be passed on as higher prices
why does friedman disagree with the phillips curve idea of menu of choice?
there is no choice because you can have both high inflation and high unemployment
what did friedman argue that the phillips curve didnt take into account (won him a Nobel)?
the phillips curve doesnt take expectations into account
eg if we have inflation or unemployment we may save more
what was friedman’s conclusions?
an increase in AD
in the short run may encourage firms to expand output
take on more workers
unemployment falls
but demand for g+s increase
inflation
workers and producers realise that inflation has eroded their real profits and wage levels
they see through the money illusion
expectations and behaviours adjust
some workers leave because of fall in real wages
increasing unemployment returning to the NRU
any future increase in AD not accompanied by an increase in LRAS will result in accelerated inflation
what are the LRPC implications?
in the long run there is no trade off between unemployment and inflation
governments are powerless to reduce unemployment by implementing expansionary fiscal and monetary policy
what type of inflation is important for efficient functioning of labour markets?
low and stable
what are the five problems with inflation?
basic costs - time and effort of changing shopping patterns and changing menus etc
distributional effects - poor members of society just get poorer as their real incomes fall and they cant negotiate real wage increases
distortion of behaviour - inflationary noise confuses consumers and firms lead to hoarding and delayed investment decisions
international competitiveness - will fall if inflation if higher than competitors
the function of money - hyperinflation makes money an inefficient medium of exchange
loose =
tight =
loose = expansionary
tight = contractionary
why do cost pressures take time to work through supply chains?
stock up on imports
once it runs out
then we will see price levels increase
