Y11 Macroeconomics Topic 2 Inflation Flashcards
What is Deflation?
Deflation is a sustained fall in the average price level of goods and services in an economy in a given period of time
What is Inflation?
Inflation is the sustained rise in the average price level of goods and services in an economy over a period of time.
What is Disinflation?
Disinflation is a decrease in the rate of inflation – a slowdown in the rate of increase of the general price level of goods and services in a nation’s gross domestic product over time.
What is the UK target for Inflation
2% 1+ or 1-
How do the Government Measure Inflation?
CPI
• Every month the government collects prices on the same basket of 600-700 goods and services purchased by 7000 typical families.
.• The prices of the 600-700 G&S are collated together and converted to an INDEX NUMBER.
• This allows comparison of prices to previous years.
• CPI represents the rate of inflation in index form.
• A BASE YEAR is selected in which the price of the 600-700 items is given the value of 100. If the price of the 600-700 items increases by 3.6% over the next year then the index will read 103.6 for that year, therefore making it easier to judge the change in prices from the previous year.
What are the two types of Inflation?
Demand-Pull Inflation
Cost-Push Inflation
What is Demand-Pull Inflation?
Inflation caused by too much agregate demand –> increased general prices
How does Demand-Pull Inflation increase?
.Rising Consumer spending encouraged by tax cuts or low interest rates
.Sharp increases in Government Spending
.Rising Demand for resources by firms
.Booming demand for exports
Why is Demand Pull Inflation more Likely when there is close to full employment?
This is because consumers, businesses, foreigner visiters and the government increase their spending levels. If businesses are close to full capacity, they will find it difficult to produce the extra output to meet this demand. As a result, they are likely to respond by raising their prices.
What is Cost-Push Inflation?
Inflation caused by rising business costs
What is the relationship between Inflation and interest rates?
Inflation may be caused when households, firms and the governmnet borrow more money from banks to fund extra spending. This adds to the money supply because there are now more bank deposits. The extra money lent by the bank creates more demand and prices are driven up. This type of inflation is more likely to increase when interest rates are low because consumers would have to pay back less
Impacts of Inflation?
.High Prices –> LOW PPP
.High Wages due to High Prices. Firms increase Prices so Workers demand Higher Wages (Cycle repeats)
.Lower Exports due to higher prices
.Reduced Unemployment in order to achieve output needed because of the increased aggregate demand (Demand-Pull Inflation)
.Increased Menu Costs (In resturants you have to update the increased prices)
.Increased Shoe leather costs
.Uncertainty (How can a supplier make profit if it doesn’t what it’s price is going to be)
.Decreased Consumer Confidence
.Decreased Investment (We don’t know how Inflation changes prices)
How do you Reduce Demand-Pull Inflation?
- Raise interest rates to reduce consumer spending. This encourages consumers to save more thus reducing the pressure from rising aggregate demand.
- Raise taxes. This will reduce disposable income and therefore reduce the ability of consumers to demand more G&S.
How do you Reduce Cost-Push Inflation?
- If possible, restrict wage increases. For example: the government can impose a wage freeze which enforces a rule that firms cannot increase wages. This is particularly effective if rising wage costs are a significant percentage of a firm’s costs.
- Force suppliers of electricity and gas (utilities) to fix their prices, helping to control business costs.
- Increase the value of a currency in order to reduce the cost of imports.
