Macro Pack 7 Flashcards
Define the term ‘CPI’
The Consumer Price Index (CPI) is a measure of inflation that calculates the average change in prices of a basket of goods and services purchased by households over time.
If the CPI rose from 140 to 145, what is the rate of inflation? (to 2 decimal places)
InflationRate=(145−140) =5 ÷140×100
=3.57%
Explain in a step-by-step way what is involved in calculating the CPI
Select a basket of goods and services that represents typical consumer spending.
Collect price data for these goods and services from different locations.
Assign weights to each item based on its importance in household spending.
Calculate the weighted price index for each period.
Compare the index over time to determine inflation.
Why is it important to use weights when calculating inflation?
Different goods and services have different levels of importance in consumer spending. Weights ensure that price changes in essential items (e.g., housing, fuel) have a more significant impact on the overall inflation rate than less essential items.
Outline at least three limitations to the CPI
Fixed basket: The basket may not reflect changing consumption patterns.
Quality changes: Improvements in product quality may not be fully accounted for.
Excludes some costs: CPI does not include housing costs for homeowners in some versions.
Explain how the RPI differs from the CPI
The Retail Price Index (RPI) includes mortgage interest payments, while CPI does not.
RPI uses an arithmetic mean, whereas CPI uses a geometric mean. RPI generally reports a higher inflation rate than CPI.
Define the term ‘demand-pull inflation’
Demand-pull inflation occurs when aggregate demand exceeds aggregate supply, leading to rising prices.
Define the term ‘cost-push inflation’
Cost-push inflation occurs when rising production costs (e.g., wages, raw materials) lead to higher prices.
Show demand-pull inflation on a diagram and give a couple of examples of what could cause this.
AD shifts right.
Increased consumer spending due to lower interest rates.
Government spending increases.
Show cost-push inflation on a diagram and give a couple of examples of what could cause this.
(Diagram needed: SRAS shifting left)
Causes:
Rising oil prices increasing production costs.
Higher wages increasing costs for businesses.
Explain how a weaker pound causes demand-pull and cost-push inflation.
Demand-pull: A weaker pound makes exports cheaper, increasing foreign demand for UK goods.
Cost-push: Imports become more expensive, raising production costs for businesses.
Explain the problem of a fall in the real value of money.
Inflation erodes purchasing power, meaning consumers can buy less with the same amount of money.
Explain the problem of loss of international competitiveness.
High inflation makes UK goods more expensive relative to other countries, reducing exports.
Explain the problem of uncertainty.
Inflation makes it difficult for businesses and consumers to plan for the future, discouraging investment and long-term contracts.
Explain the problem of menu costs.
Businesses face costs when frequently updating prices (e.g., reprinting menus or price lists).
Define the term “anticipated inflation”.
Anticipated inflation is when future inflation is predicted, and businesses and consumers can adjust accordingly.
Which is preferable: anticipated or unanticipated inflation? Why?
Anticipated inflation is preferable because economic agents can plan for it, reducing negative effects. Unanticipated inflation disrupts contracts, reduces real incomes, and creates uncertainty.
Draw and explain good deflation
(Diagram needed: LRAS shifting right)
Good deflation occurs when lower costs of production increase supply, leading to lower prices and higher output.
Draw and explain bad deflation
(Diagram needed: AD shifting left)
Bad deflation occurs when falling demand reduces prices and output, leading to unemployment and economic stagnation.
Explain one reason why deflation may be beneficial
Lower prices can increase consumer purchasing power, boosting demand.
Explain the drawbacks of deflation
Encourages consumers to delay purchases, reducing demand.
Increases the real burden of debt.
Can lead to a deflationary spiral and economic stagnation.
