Revision Flashcards
Definition of inflation
A sustained rise in the average price of goods within an economy.
What is the current rate of inflation?
1.8% but the government aims for it to be 2%.
What are the two measures of inflation in the UK?
– RPI(retail price index)– this includes housing price
– CPI (consumer price index) – used by rest of Europe.
What are the cost-push causes of inflation?
– Rising wages simulated by expectations of workforce.
– Rising taxes.
– Increasing cost of raw materials (influenced by weather regulations etc).
What are the demand-pull causes of inflation?
– Rise in consumer spending (stimulated by tax cuts or growth in economic activity).
– Increase in investment by firms.
– Rise in government spending.
– Increase in exports.
Does inflation matter?
What are the effects of high levels of inflation?
– UK firms get competitive.
– Causes uncertainty which means it’s harder to predict the future.
– Increases wage demands of workers which may lead to a wage price spiral.
What is the definition of deflation?
– Tendency towards a decline in the general price level.
What are the effects of deflation?
– It causes lower demand/lower costs.
– It causes uncertainty.
– Consumers reduce demand which means there is low investment which causes the deflation spiral.
What is a wage price spiral?
– When workers bid for higher wages as they find their real income have been a row did by rising prices.
– This can lead to cost push inflation and then demand for higher wages again causing further inflation.
What is uncertainty and lower investment?
-inflation changes make it harder for firms to predict costs and revenues and so they may be deterred from investment projects.
Why is there a falling competitiveness when inflation rises?
- exports become relatively more expensive and imports become relatively cheaper.
- The trade position will therefore deteriorate unless the exchange rate deteriorates to compensate.
What are Shoe-leather costs?
– When the opportunity cost of holding cash increases people will keep more money in interest-bearing account’s making more trips to the bank necessary.
Cost of inflation- income is redistributed as:
– Those on fixed incomes such as pensioners seem real incomes fall and the real value of their savings also fall.
-borrow his benefit as the real value of debt is eroded.
Definition of exchange rate
-an exchange rate is the price of one countries currency in relation to that of another.
What are the factors that affect the exchange rate?
- Trade: the relative level of imports and exports.
- Interest rates
- Government intervention : can manipulate currency.
- Speculation
- Investment and Capital flows.
Affects of a depreciating pound:
- Fall in pound improves UK export competitiveness.
- A falling pound pushes import prices up, reducing their competitiveness.
- makes imports more expensive and exports cheaper.
Affects of appreciation of the pound:
- cheaper imports and more expensive exports.
- decreases competition for UK exports.
Business trade cycle:
- Boom
- Slowdown or economic slump
- Recession
- Recovery
- GPD y axis
- Time x axis
Definition of the real interest rates.
- Rate of interest an investor, saver or lender receives.
- Real income = rate of income after inflation = 2.4 - 1.8 = 0.6%
What is a budget deficit?
-An indicator of financial health in which expenditures exceed revenue. Government tends to borrow.
Why do low interest rates lead to higher company investment?
- make it cheaper to borrow so it encourages businesses to invest.
- reduces the incentive to save.
Trade Cycle points:
- In a recession, less people are likely to buy luxury’s such as organic food, going out to eat in expensive restaurants and products with high income elasticities. Demand is likely to decrease for them.
- Necessities such a toilet paper, and certain foods will feel little impact as people will always buy them.
- inferior goods will see a rise in demand as people ‘trade down’.
- producers of luxury goods may have no choice but to cut costs and lower prices to survive unless they can adapt their products to the new economic environment.
- growing unemployment.
Business cycle definition:
-The sequence of recession, recovery, book and downturn which many economies go through.
Definition of recession:
-involves 6 months or more of falling GDP. Often involves a general pessimistic business mood and falling level of demand and employment.
