LS8- Inflation Flashcards
Define inflation
Inflation is a sustained rise in the average price of goods and services over a period of time
How is inflation measured?
Use indexes with the methods of CPI and RPI
How is the inflation index calculated?
A living costs and goods survey is carried out to find a basket of goods and their weight
The price of these goods are recorded in different areas of the country
Prices are averaged and converted
Why must items be weighted?
So the the value is more accurate
Compare cpi and RPI
CPI uses geometric means while RPI uses arithmetic means which is less accurate
CPI excludes mortgage, interest rate payments and council tax
RPI excludes the top 4% of incomes and pensioners
What is the redistribution method?
Inflation can be used to redistribute income by making some people better off and some worse off
Who are the people that lose from inflation
People with a fixed income Land lords, people who receive welfare People whose wages increase less rapidly than inflation(fall in real income) Cash holders Savers Lenders(depends on interest rate)
Who gains from inflation?
Borrowers
Payers of fixed income wages
Payers of income which doesn’t increase with inflation
What are some other consequences of inflation?
Uncertainty about future changes causing reduced investment
Standard of living may fall
Menu costs(because changing prices)
People think they are better off with a nominal wage growth
Inflation causes exports to become less competitive
Why is deflation bad?
It shows that the economy is failing because AD falls and unemployment rises
People think that prices are falling so will fall more so they cut back spending
Less spending means less revenue and economic growth
What is demand pull inflation?
When AD rises and there is no increase in supply, demand pull inflation occurs
Caused by excess demand causing price level to rise
When AD shifts right there is greater pressure on FOP to produce more so they become scarcer, causing price to rise which is passed to consumer
What causes demand pull inflation?
High consumer spending caused by high confidence Low interest rates Tax cuts Increased demand for exports Gov spending rise Growth of money supply
What is cost push inflation?
Is caused by rising costs on the supply side, causing SRAS to shift left which firms pass on to consumers to maintain profits
What causes cost push inflation?
Wage rises lead a rise in cost. Wages are sticky downward so a rise in good prices requires a larger rise in wages
Higher import prices Rise in raw material cost Rise in indirect tax Cut in subsidy Depreciation of exchange rate
