LS8- Inflation

Question 1

How is inflation measured?

Answer 1

Price of a basket of goods is recorded on a regular basis
Living costs and food survey used to record household expenditure on g/s
Average price of goods calculated, converted to index number form
G/S are weighted in terms of importance depending on proportions of income spent on the g/s

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 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 lower rate than the rate of inflation- fall in real income

Holders of cash- value of cash drops

Savers- if inflation is higher than rates 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 hs fallen, losing purchasing power

Question 5

Groups who gain from inflation

Answer 5

Borrowers- borrowing at a lower interest rate than inflation means 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

Problems of using CPI to measure inflation

Answer 6

• The basket of g/s generated will not necessarily reflect the consumption habits of all consumers in the economy- higher incomes may spend differently to lower incomes e.g luxury goods
• May be an error in the data collection
• There will be always be issues with how quickly the basket of goods and services is changed according to changes in the consumption habits of a nation
• The CPI basket is also prone to seasonal fluctuations

Question 7

Demand-pull inflation

Answer 7

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
- cut in interest rates will reduce the cost of borrowing, eventually causing a right shift in AD due to higher consumption- also reduces the rate of return on savings so consumers more likely to spend than save- reduce costs of variable rate mortgages
- government may be increasing spending, or cutting taxes
- firms may increase spending on investment- responding to large increases in demand by increasing working capacity

Question 8

Cost-push inflation

Answer 8

Cost-push inflation occurs due to rising costs

Wage increases- increased costs of production- inflation

Imports- world economy booms, prices of goods internationally increases, imports in the UK become more expensive

Firms looking to maximise profits may increase prices

Govts may increase taxes and reduce subsidies increasing the costs of production