Lesson 9 - Inflation And Deflation

Question 1

What are the 4 types of inflation?

Answer 1

• demand pull
• cost push
• imported
• monetarist explanation

Question 2

What is demand pull inflation?

Answer 2

• increase in aggregate demand
• begin to suffer supply constraints
• costs rise for firms
• they reflect this with an increase in prices (inflation)

Question 3

What is cost push inflation?

Answer 3

• increases in costs for reasons independent of demand
• reflected in an increase in prices (inflation)

Question 4

What is imported inflation?

Answer 4

• weak currency
• increases the price of imports
• leads to the increase in the price of domestic goods as they try to compete
• leads to imported inflation

Question 5

What is the monetarist explanation for inflation?

Answer 5

• if the stock of money increases, more of it is spent on goods and services
• this boosts AD
• if LRAS does not respond with an increase, then price levels will increase, leading to inflation

Question 6

What are the 4 causes of inflation?

Answer 6

• too much demand
• rising costs
• weak pound
• increase in the money supply

Question 7

What are the consequences and solutions for imported inflation?

Answer 7

Consequences
- expectations adjust
- leads to the wage price spiral (pushing for higher wages - increase in costs - increase in prices)

Solutions
- strengthen the pound (increase interest rates - reduce AD, lowering inflation)(buy pounds using our foreign currency reserve to increase its value)

Question 8

What is the money illusion?

Answer 8

People think that the nominal value of their money equates to its real value, so they think that they have more spending power than they actually do

Question 9

What are the consequences and solutions for the monetarist explanation of inflation?

Answer 9

Consequences
- arbitrary redistribution (wealth is redistributed from lenders to borrowers, since they benefit from the fall in the value of money, and therefore their debt)

Solutions
- reduce the money supply (selling bonds)

Question 10

Define the concept of deflation

Answer 10

• sustained fall in the general price level
• associated with recessions and depressions

Question 11

What is the impact of deflation on debts?

Answer 11

• rise in the value of money, so the value of debt increases
• shatters confidence
• leads to the debt trap (people borrow even more money to pay off their previous debt)

Question 12

What is the impact of deflation on confidence?

Answer 12

UK is a nation of home owners, so increases in the value of money has a big impact on confidence
- house prices will fall, shattering confidence