Topic 2.16 - Inflation

Define inflation?

A rise in the general price level

Define deflation?

A fall in the general price level

Define hyperinflation?

Rapid inflation above 50% a month

Define disinflation?

A rise in the general price level, but at a lower rate than before

What is the easiest way to tell that a value is showing deflation and not disinflation?

Deflation shows a negative value

What is the main measure inflation used across the world?

The consumer price index

Other than CPI what is another useful measure of inflation?

Retail price index

What does CPI stand for?

Consumer price index

What does RPI stand for?

Retail price index

What is the difference between CPI and RPI?

The RPI has everything from the CPI but also includes the costs of housing

What does the Bank of England look at when it decides whether to change interest rates?

The inflation rate as measured by the CPI

When workers organisations like trade unions negotiating pay rises what do they prefer them to be based on?

The RPI figure for inflation because this is usually the highest

To calculate the CPI rate of inflation what do government statisticians do?

They select the most popular and representative products in the UK

What is another important measure of inflation that is not CPI or RPI?

CPI core inflation

What does CPI core inflation do?

Takes out food and fuel prices from inflation because these products are very popular and therefore distort the true inflation picture

What are the 2 causes of price rises

1. A rise in demand across the economy

2. A rise in costs across the economy

What type of inflation does a rise in demand cause?

Demand pull inflation

What type of inflation does a rise in costs cause?

Cost push inflation

What is demand pull inflation?

When prices rise due to an increase in demand for many goods and services

What are the 4 stages that lead to demand pull inflation? (In order)

1. UK government cuts rate of income tax

2. Households have greater disposable income so can spend more than before

3. Creates more demand than before for goods and services so firms can charge more

4. Leads to a general increase in price level and therefore a rise in the rate of inflation

What is cost push inflation?

When prices rise due to an increase in one or more important cost of production

What are the 4 stages that lead to cost push inflation? (In order)

1. The price of a good (like a raw material) rises, due to a fall in supply e.g. oil

2. Almost all firms use this, this means a higher costs for the firms who buy it

3. In order for firms to preserve profit levels, firms raise their prices for consumers

4. Leading to a general increase in price level and therefore the rate of inflation

What 3 factors can further increase inflation after demand push and cost push pressures?

• The wage

• Cost

• Price spiral

How does inflation become hyper inflation

Governments printing more money to pay debts. The extra supply of money leads to higher prices meaning more printing needed

What are the 4 parts of the wage, cost, price spiral in order?

1. Prices go up

2. Workers wages are worth less, so they ask for more

3. Firms pay higher wages

4. Firms cost of production rises

What are the 3 ways to break the wage, cost, price spiral?

1. Firms should not pay higher wages

2. Attack workers organisations (trade unions) as it takes away their power so they will be not be as successful when getting wages increased

3. Keep prices down using a maximum price scheme

Which 2 problems begin when there are low levels of inflation?

1. Loss of purchasing power

2. Effects on saving/borrowing

Why does a loss of purchasing power occur when there is inflation?

Any inflation means (ceteris paribus), a given amount of money can buy less than before

What are the effects on saving and borrowing when there is inflation?

If inflation is greater than interest rates, savings lose value over time, so does the value of borrowing. Saving is discourages and borrowing is encouraged

Which 4 problems begin when there are mid levels of inflation?

1. Effects on interest rates

2. Labour unrest

3. Uncertainty about prices

4. Effects on international competitiveness

What is the only problem that occurs when there is higher inflation?

Complete breakdown of the economy

What are the effects on interest rates when there is inflation?

Will have to raise them to control inflation which has negative effects on AD due to the effects on consumption and investment

What percentage counts as mid levels of inflation? (approximately)

4%

What are the effects on labour and unrest when there is inflation?

Workers demand higher wages to compensate for reduced purchasing power of their income. They may strike which can affect production and productivity

What are the effects of uncertainty about prices when there is inflation?

Firms can’t estimate future prices and profits. Households cannot plan their finances for the future

What are the effects on international competitiveness when there is inflation?

Higher inflation rates than competitors means export prices become higher so export earnings fall

What are the effects of complete breakdown of the economy when there is inflation?

Money has lost its worth, workers stop working and firms stop accepting money for their goods. Less is produced, essential services stop and shops have nothing to sell

If inflation rises to high rates what leads to the total breakdown of the economy?

The value of workers wages and businesses revenue declines so workers stop working and businesses stop accepting money

What is the only solution to ‘solve’ hyper inflation?

To change to a completely new currency which firms will start to accept as payment

What is the negative effect for the only solution for hyperinflation?

All savings and loans taken in the old currency will be wiped out meaning the population will become poorer

How do you calculate the index number for the year?

(Basket cost for this year/basket cost in base year) x 100

What is good deflation?

When it is caused by a shift out of SRAS

How is good deflation usually caused?

Long term improvements in technology which makes necessities cheaper

What is bad deflation?

Deflation caused by a shift in of AD due to a recession

What does bad deflation cause?

A deflationary spiral

What are the 3 stages of a deflationary spiral? (In order)

1. A fall in demand causes prices to fall

2. Consumers postpone spending thinking prices will fall again

3. Businesses cant sell anything, so cut prices