4.7 partial

Inflation

Sustained increase in the general price level of the economy overtime

Mild inflation

Low rates of inflation of 1-2% usually not harmful for the economy

Hyper inflation

Type of inflation during which prices rise at phenomenal rates and money becomes almost worthless

Deflation

Sustained fall in the general price level

Disinflation

Fall in the rate of inflation

Inflation rate formula

(price index of current year - price index of previous year) / price index of previous year

Price indexes

CPI

RPI

CPI/ RPI

Consumer/ retail price index

Measure of inflation

Cost of living using weights

Basket of goods and services

How to measure inflation/ CPI/ RPI

Government select base year

Government officials carry out surveys of household expenditures to find out spending patterns of individual

Construct basket of goods and services normally purchased by average households or family

Price of those goods and services are gathered from a number of different retailers even online ones across the economy

Products given different weights which represent proportion spent on the item and their importance in buying patterns

Construct weighted price index which is calculated by multiplying the weights by the new price index

For each category of products to calculate the change in the general price level or it can be calculated directly by multipying the weight of the percentage change in the price indices

Inflation rate = CPI in year 1 - CPI of base year

If the CPI of year one was 105, the inflation rate has risen by 5 %

How is the base year selected?

Government select a standard year in which there were no dramatic changes which is always given 100 and price level of other years are compared to it

How do you find out how house holds spend their income

Government officials carry out surveys of household expenditures

Why is it important to find out how households spend their money

Price changes in an item which people spend a large proportion of their income on will have more impact on the cost of living then an item which they spend a small amount on

How are weighted price index constructed

By this stage the weights of each product have been assigned in the index and the change measured in their prices overtime

The weights are multiplied by the new price index for each category of product to calculate the change in general price level

Price index

Shows how much the price of that item has risen compared to a base year

Weighted price index

Price index times the weight attached to the product category

Types of inflation

Cost push inflation

Demand pull inflation

Cost push inflation

Price level is pushed up by the increase in the costof production leading firms ti raise their prices to maintain their profit margins

Cost push inflation chain of reasoning

Increase in cost of production decreases aggregate supply causing it to shift to the left inward causing higher prices and lower national income

The rise in the general price level will likely cause workers to ask for even higher wages causing even higher costs causing even more inflation causing a wage price spiral

What can be on x axis of an AD and AS diagram

Real GDP or National income

How do you calculate nominal GPD on AS and AD diagram

Real GDP x Price levels