Macro 8 - Causes and consequences of Inflation

Question 1

What are the 2 causes of inflation?

Answer 1

1. Demand pull inflation
2. Cost push inflation

Question 2

Why does demand pull inflation occur?

Answer 2

AD increasing faster than AS

Question 3

Illustrate demand-pull inflation using a diagram

Question 4

Why does cost push inflation happen?

Answer 4

Because of an increase in cost of production
e.g - energy prices increase

Question 5

Show cost push inflation using a diagram

Question 6

What other factors could increase cost of production?

Answer 6

Inflation in other countries

Question 7

What are the 7 costs of inflation?

Answer 7

1. Shoe leather costs
2. Menu costs
3. Uncertainty for firms
4. Loss of competitiveness
5. Fiscal Drag
6. Wage price spiral
7. The effect on the pensioners and savers

Question 8

What are shoe leather costs?

Answer 8

Shoe leather costs are the financial costs that are made by households in times of high inflation.

e.g - Trips to store to purchase goods or convert to a stable currency.

Question 9

What are menu costs?

Answer 9

The costs incurred by a firm when it changes it’s prices, printing new price stickers.

Question 10

What is the evaluation for shoe leather costs?

Answer 10

Depends on the extent of inflation

Question 11

What is the evaluation for menu costs?

Answer 11

Menu costs only occur during periods of hyperinflation

Question 12

What is uncertainty for firms?

Answer 12

During high inflation, this usually implies there is high likelihood of negative economic future. So, there will be less investment into captital

Question 13

What is the evaluation of firms being uncertain?

Answer 13

Inflation may be short term, so firms may still invest

Some firms can afford to invest in periods of high inflation

Question 14

What is loss of competitiveness?

Answer 14

Exports become more expensive.
Countries stop importing from UK.
UK becomes less internationally competitive

Question 15

What is the evaluation for loss of competitveness?

Answer 15

Some exports have inelastic demand. So, demand may not fall as some products such as gas are bought on long term contracts.

Question 16

What is fiscal drag?

Answer 16

Taxpayers are moved into higher tax brackets as wages rise.

Question 17

What is the evaluation for fiscal drag?

Answer 17

Depends on whether someone is near a tax bracket

Current fiscal drag and inflation is extreme and may only happen once in a lifetime

Question 18

What is wage price spiral?

Answer 18

As prices increase, firms are forced to increase wages, prices continue to increase.

Question 19

What is the evaluation for wage price spiral?

Answer 19

Firms may not pass on increased costs to customers

Question 20

What wage/price cycle is the UK in?

Answer 20

Uk is in price-wage cycle

Prices increase due to cost push inflation
Wages are increased

Question 21

What is the triple lock system?

Answer 21

The Triple lock system is what decides how pensions are increased

Question 22

What are the 3 factors of the triple lock system?

Answer 22

1. +2.5% each year
2. CPI
3. Wages

Question 23

What is the effect of inflation of pensioners and savers?

Answer 23

Pensioners benefit as the Triple lock system means that pension increase with inflation.

Savers lose out as their purchasing power is eroded over time

Question 24

What is the government’s ideal inflation rate?

Answer 24

2%

Question 25

Who benefits from moderate level of inflation? (2%)

Answer 25

1. Firms 2. Borrowers 3. Government

Question 26

Why do Firms benefit from moderate inflation (2%)

Answer 26

Firms can charge higher prices (greedflation)

Question 27

Why do borrowers benefit from moderate inflation (2%)

Answer 27

They pay back less

Question 28

Why does the government benefit from moderate inflation?

Answer 28

Inflation is a sign of growth

Question 29

What reasons depict whether or not inflation is harmful to the economy?

Answer 29

1. Cause of inflation 2. Extent of inflation 3. Group affected

Question 30

How does the cause of inflation depict whether inflation is harmful to the economy?

Answer 30

Cost-push is harmful as it doesn't show economic growth, it increases costs but reduces growth

Question 31

How does the group considered / affected depict whether inflation is bad for the economy or not?

Answer 31

Wealthy households are affected less Low income groups affected more as purchasing power falls and they spend more on necessities

Question 32

Illustrate how deflation can be caused by supply-side effects. Give chains and imagine the graph. also what is the effect of this onto UK exports?

Answer 32

Costs of production / firm invests in capital and becomes more productive LRAS Shifts right GDP increases from Y1 to Y2 PL decreases from P1 to P2 Exports become more internationally competitive as they become cheaper

Question 33

Illustrate how deflation can be caused by demand side effects

Answer 33

GDP decreases PL decreases Net exports increases Unemployment increases

Question 35

How does the extent of inflation depict whether inflation is harmful to the economy?

Answer 35

Hyperinflation is bad because firms become uncertain and don't invest into capital goods.