UNIT 3 AOS 2 - part 2 - price stability

Question 1

define

Low and stable inflation

also known as price stability

Answer 1

The government (via the RBA’s) goal of low and stable inflation is to manage the increase in the general prices levels of goods and services, between 2-3% on average over time, measured by CPI.

Question 2

define

cost ….. inflation

(also whats …..)

AND WHATS A DIFFERECE b/w AD and AS

Answer 2

• general price levels caused by cost pressures
• independent of AD (expenditure)
• pass on increases in cop of consumers through higher prices (unless they cut profit or increase productivity)

cost PUSH inflation

Question 3

define

demand……. inflation

(also whaTs …….)

Answer 3

• rises in the general price level causes by excess spending or demand pressures
• creates shortages and puts upwards pressure on prices
• AD>AS

demand PULL inflation

Question 4

define

inflation, DISinflation, DEflation

+ DIFF

Answer 4

inflation
* sustained increase in the general or average price levels (of g/s) over time

DISinflation
* occurs when the rate of inflation remains positive but lower than previously.
* E.g. from 2.6% to 1.5%.

DEflation
* a sustained decrease in the average price level over time (negative rate of inflation)

=========–
DIFF
Disinflation vs deflation
* Periods of disinflation can be good for a country if they had high inflation before (if they need to lower their inflation to the goal of price stability)

• Whereas Deflation is always bad as it send singals of: economy not expanding - SSG

Inflation vs Deflation
* deflation is always outside the goal (since -ve) whereas inflation will sometimes be in the goal

Disinflation vs Inflation
* if Australia had high rate of inflation then disinflation is always good for interntional competivenss when Austrlaia’s inflatoin is greater than our trading partners
* disinflation is always good for int competitiveness whereas inflation is always bad

OR: A sustained increase in the general or average price level overtime

Question 5

define

Underlying inflation, Headline inflatio]]] DIFF+ DEF

(and diff with headline)

Answer 5

UNDERLYING
* Headline CPI minus volatile items that fluctuate grossly over time (e.g. Fuel, fruit and veggies) to indicate the real change in prices for households and to determine the trimmed and weighted mean.

HEADLINE
* raw inflation rate created by measuring changes (all price movements) in CPI
* e.g., removes volatility of changes in petrol prices

DIFF

• The underlying rate is used by the RBA to indicate whether it should increase or decrease the cash rate

Question 6

How is inflation measured?

(not the formula)

Answer 6

measured using the CPI which is an index that tracks changes in over 100,000 g/s in a baseket (regimen) and weights them based on importance over a period of time (typically quarterly/monthly) where the data collected is only in metropolitan areas

only in suburban areas

DID I SAY “TRACK CHANGES”

Question 7

Inflation forumla

what is annual and annualised rate?

Answer 7

(y2 −y1)/y1×100

• annual rate = prices increased over 12 months
• Annualized rate = quarter of inflation (x4 to make annual rate)

Question 8

consequence of high inflation

Answer 8

CHECK ORDER OF 2: LOSS IN INT COMP IS BEFORE LOWER NX

1/ erodes (lower) purchasing power
* ↓real value of money
* erodes purchasing power
* likely reduction in real wages (for ‘low skilled’ workers or low income earners on fixed incomes)
* bracket creep - individuals move into higher tax rate
* = ↓ effects of reducing disposable income
* ↓Acess to g/s

2/ Loss in international competitiveness
↓ real value of money
=erosion of purchasing power
=Aust g/s appear more expensive relative to another countries g/s then previously (since the rate of inflation is rising and tends to be higher than the trading partner’s rate of inflation)
= trading partner incentives to trade with other trading partner
= loss of international competitiveness
= ↑M and ↓X
= ↓AD = ↓ production = ↓DDL = ↑UNN = ↓Access to g/d

3/ wage-price inflation spiral
↑inflation
=↓ real wages
= (↑ demand higher wages)
= ↑ COP
= ↑ cost inflation (since firms try to maintain profit margin and tend to pass on higher prices to consumers)

4/ Loss of efficiency
* ↑prices
* investor redirect funds into ‘safer’ invs that are less productive (e.g., term deposits)
* re-direct resources away from their most allocatively efficient
* ↓production levels (production capacity)
* ↓ TE & ↓AE

5/ Consumer expectations (of quality of g/s)
* ↓ expectations

6/ High raw materials
* ↑COP

if wages do not keep up

For erdoes purchasing power check if redfuction of real wages is after erdoe puchasing power

Question 9

consequence of low inflation

Answer 9

1/ business see ↓ profits
= ↓ incentive to produce
= ↑ unemployment
= ↓ production
= ↓ MLS

2/ Inflation expectations (cons has low inflationary pressures)
= expect prices to fall
= may delay c/I expenditure
= ↓ AD
= ↓ production
= ↓ EG
=↓ DDL
= ↑ UNN

(e.g., housing market -> people way wait for houses to decrease further before buying = delayed expenditure)