LS8 - Inflation Flashcards
Inflation
A sustained increase in the general level of prices one a period of time (leading to a fall in the purchasing power of money).
Deflation
General decrease in the price level over time.
Disinflation
Reduction in the rate of inflation e.g. from 3% to 2% so it’s still positive.
Hyperinflation
Very high and usually accelerating rates of inflation, rapidly eroding the real value of the local currency.
Objective Of Inflation
To have price stability i.e. low and stable inflation which happens when prices don’t change.
CPI
A weighted price index which measures the change in the prices of goods and services (UK).
Calculation CPI
The ONS find the typical goods bought by households and use it to decide how to weigh each category of goods and services based on its importance to the budget, calculate the increase to the price index through finding the weighted average change and then use the price index to calculate the inflation.
CPI Equation
(Current Year Index - Previous Year Index)/Previous Year Index
Difficulties In Measuring Inflation
Basket may not be representative making it difficult to judge a typical household.
New technology entering the market makes it difficult to calculate a change in price.
Doesn’t take into account increasing quality with price.
Sampling errors.
Consequences Of Inflation
Redistribution Effects Uncertainty Menu Costs Money Illusion International (Export) Competitiveness
Redistribution Effects
Inflation redistributes income away from certain groups and towards others, some groups lose some purchasing power whilst others gain purchasing power e.g. holders of cash lose purchasing power and borrowers may be paying lower interest rates so benefit.
Uncertainty
It doesn’t allow people to accurately make economic decision as they don’t know what will happen to their purchasing power, resulting in fewer investments and less economic growth.
Menu Costs
Firms like restaurants have to print new menus to align with current inflation as they have to increase their prices.
Money Illusion
Some people think they’re better off when their nominal wages increase, despite an increase in the general price level meaning they’re worse off.
International (Export) Competitiveness
When the price level in certain countries increase quicker than others, exports become more expensive to foreigners and imports become cheaper meaning exports fall whilst imports rise.
Cost-Push Inflation
Changes to the supply side of the economy leading to rising costs e.g. production costs increasing meaning firms have to increase prices to maintain profit margins.
Demand-Pull Inflation
Increasing AD outstripping AS, therefore causing a rise in prices e.g. a surge in demand for oil without a high supply of oil causing oil prices to significantly increase.
Factors Causing AD To Increase
Depreciation Of The Exchange Rate.
Higher AD From A Fiscal Stimulus e.g. reduction in taxation.
Monetary Stimulus To The Economy e.g. reduction in interest rates and increase in investment.
Faster economic growth than other countries, a boost to UK exports and therefore a boost in spending and consumption.
Wage Price Spiral Example
Increase in oil prices leads to an increase in firms’ production costs, leading to a rise in firms’ prices, leading to an increase in the general price level, meaning workers demand higher pay rises, Because there has been a fall in real income, This leads to an increase in firms costs of production, This means that firms must increase prices to maintain profits which is a wage-price spiral.
Hyperinflation
When Prices rise so rapidly that the value of money becomes worthless.
Causes Of Hyperinflation
Citizens Not Buying Bonds
Panic Buying
Citizens Not Buying Bonds
When citizens and foreigners won’t buy bonds and raising taxes isn’t enough forcing the bank to print more currency and the government then spends this money into the economic.
Panic Buying
Once high inflation is expected, consumers bring forward their purchases and firms will raise prices and workers will demand higher wages.
Deflation
A sustained fall in the general price level over a period of time.
Consequences Of Deflation
Lower Profits
Real Wage Unemployments
Deflationary Spiral
Lower Profits
Company profits will be squeezed leading to unemployment as firms reduce costs.
Real Wage Unemployment
Workers resist nominal wage cuts therefore during deflation real wages rise leading to higher production costs and firms reducing the workforce.
Deflationary Spiral
Consumers and firms may delay spending money reducing AD, lowering prices and output overall, reducing consumer and business confidence alongside government policies.
Benefits Of Deflation
Increased Efficiency
International Competitiveness
Increased efficiency
Deflation from increased efficiency and lower costs of products cause the AS to shift to the right lowering price levels and increasing real GDP.
Solving Demand Pull Inflation
Fiscal and monetary policies will be used to reduce AD.
Solving Cost Push Inflation
The government will try to reduce production costs.
Supply Side Policies
Increase productive capacity and help address inflation.
Inflation Targeting
Convinces people inflation is under control, meaning consumers will not bring forward purchases, workers may press for lower wage prices and firms may not push their prices just to cover expected higher costs, this prevents a wage-price spiral.
