MACRO - 3. inflation and deflation ✅

Question 1

what is the difference between inflation, deflation and disflation

Answer 1

INFLATION = sustained general rise in prices whereas DEFLATION = sustained general fall

DISFLATION is fall in rate of INFLATION eg from 3% to 1%

Question 2

what is the difference between HYPERINFLATION and STAGFLATION

Answer 2

HYPERINFLATION = very high inflation levels whereas STAGFLATION is when inflation is high or rising when economy is in recession

Question 3

what is REFLATION

Answer 3

rise in GDP occurring following a recession

Question 4

how can deflationary policies be implemented

Answer 4

DEFLATIONARY POLICIES are used by governments to reduce rate of economic growth and inflation rates but could cause deflation if unsuccessful

Question 5

how is inflation measured

Answer 5

consumer price index (CPI) - used across EU and Bank of England to measure inflation against target

retail price index (RPI)- excludes items relating to housing unlike CPI, used for over 60 years

Question 6

what are the drawbacks of using price indexes

Answer 6

only measures average rate of inflation for all households
can be argued to overestimate and fail to take into account falling cost of living to purchase improved goods/services

Question 7

how can demand pull inflation cause inflation

Answer 7

if AD or total demand increases without AS increase
caused by excess demand and PL rises then

Question 8

what can cause excess demand in an economy

Answer 8

• increase consumer spending due to low interest rates = large spending, rising confidence as house prices increase
• investment increases responding to AD increase and extra capacity needed to meet demand
• cut taxes/ increased government spending
• world economy boom so export demand increase

Question 9

how does money supply influence demand pull inflation

Answer 9

• money supply causing demand pull bc banking systems operate money flow

increased lending = money supply growth, consumers likely to spend borrowed money

Question 10

what causes cost push inflation

Answer 10

changes in supply side economy , rising costs = cost push

Question 11

what are major sources of increasing costs

Answer 11

• wages = 50% of national income, wages increase = cost of production increases
• imports rise in price, boom in economy = commodity prices increase = higher import prices
• firms attempting to increase profit margins by raising price. higher price inelasticity = demand decrease.

firms pass on cost increases to consumers to maintain profit margins, price increase = inflation

Question 12

how is growth in terms of spending patterns and unemployment influenced by high inflation

Answer 12

makes firms planning harder to decrease in investment in uncertainty —> disrupted spending patterns so lower output levels —> lower economic growth = high unemployment

Question 13

how is competitiveness influenced by high inflation

Answer 13

• high inflation = balance of payment effect
• domestic economy lost jobs = lower growth due to higher inflation in UK than other countries so more competitive imports, less competitive exports

Question 14

how is distribution influenced by high inflation

Answer 14

• inflation = redistribution in income, wealth between households, firms and the state
• redistribution due to income adjusted to inflation = real interest rate changes as a result of inflation and taxes/government spending in line with inflation

Question 15

how are consumers influenced by high inflation

Answer 15

• price increases mean consumers less likely to purchase as less wealth
• redistribution of income affecting existing social order

Question 16

how are consumers/companies spending patterns and cash held influenced by high inflation

Answer 16

• consumers/companies less aware of reasonable price when inflation occurs, more shopping around
• high inflation = less cash held, cash less value
• larger opportunity cost of holding cash, the higher inflation rate
• more transferring of money = lost time (cost)

Question 17

how are ‘menu costs’ influenced by high inflation and what are pros and cons of indexation

Answer 17

• inflation = restaurants changing menus, shops changing tags, new price lists showing increased price
• anticipated inflation = planning = reduces costs

pros of indexation (wages/taxes increased in line with inflation) - reduces inflation costs
cons of indexation - government less pressured to solve cause of inflation so further costs

Question 17

how does deflation influence consumer confidence

Answer 17

• low confidence as high unpredictability
• lack of confidence = less business confidence, less investment

Question 18

how does deflation influence saving and borrowing

Answer 18

• borrowing costs are high but low interest
• deflation encouraging saving but spending needed for economic growth so it drops
• real value of debt increases, discourages borrowing/spending so AD decrease

Question 19

what are benefits of low inflation

Answer 19

• allows policy makers to make room to adjust economy if inflation changes and value of borrowing decreases
• easier to finance consumption/investment to repay borrowings
• 2% target