LS8 - Inflation

Question 1

How is inflation measured?

Answer 1

Prices of a basket of goods and services is recorded on a regular basis.
Living Costs and Food Survey used to record household expenditure on g/s
Average prices of selected goods calculated, converted to index num form
G/S are weighted in terms of importance - food given more weightage than tobacco - larger proportion of income spent on food

Question 2

Difference between RPI and CPI

Answer 2

RPI - arithmetic mean; includes housing costs, mortgage payments, Council Tax; excludes top 4% of earners and low income pensioners
CPI - geometric mean; excludes housing costs; includes all households and all incomes
RPI always greater values than CPI

Question 3

Redistribution effects

Answer 3

Inflation redistributes money from certain groups in the economy to other groups.
Occurs when certain groups become worse off and lose purchasing power, while others become better off and gain purchasing power.

Question 4

Groups who lose from inflation …

Answer 4

People who receive fixed income - purchasing power of income falls; if wages increase at a rate lower than the rate of inflation - fall in real income
Holders of cash - real value and purchasing power of cash falls as price level increases
Savers - if inflation rate is higher than rate of interest, savers will lose money as real value of savings fall
Lenders - when borrowed money is returned, nominal value is the same, but after inflation, real value of the money has fallen, losing purchasing power

Question 5

Groups who gain from inflation …

Answer 5

Borrowers - borrowing at a lower interest rate than inflation means that the lender receives money with lower real value, so borrower is better off
Payers of fixed incomes - real value that you have to pay others decreases, so you would be better off

Question 6

Demand-pull inflation

Answer 6

If AD increases, without an increase in AS, demand pull inflation occurs, as price of goods increase, caused by excess demand.
Causes of demand-pull inflation:
* Consumer spending may increase rapidly - interest rates could be low, so more spending on credit cards, or consumer confidence is increasing
* Firms may increase spending on investment - responding to large increases in demand by increasing working capacity
* Govt may be increasing spending, or cutting taxes
* World demand for UK exports might increase
* Growth of money supply - more lending –> more spending –> increase in AD –> inflation

Question 7

Cost-push inflation

Answer 7

Cost-push inflation occurs due to rising costs
* Increase in wages - increase in costs of production - inflation
* Imports - world economy booms, prices of goods internationally increases, imports in the UK get more expensive
* Firms looking to maximise profits will increase their prices - inflation
* Govts may increase taxes and reduce subsidies increasing the costs of production