Economic Growth & Inflation - Causes & Consequences

Actual growth & causes (incl. PPF)

• % change in GDP

• Point moves outwards towards FE (full employment), frontier doesn’t shift [movement]

• Causes: economy is below FE & increase in components of AD/”decreased production cost = increased SRAS”

Potential growth & when (incl. PPF & eval)

• Change in productive potential of the economy over time

• Frontier shifts and point moves outwards [shift]

• Causes: economy is in FE & increased “Q²CELL = LRAS”

• Eval.: hard to measure

How international trade affects economic growth

• Initially: increased exports = increases AD (effective for Germany/Japan/China & prevents poor balance of payments)

• Sustained high export levels = firms must invest & increased demand for labour = economic growth

• In order to be competitive globally: increased efficiency

• However, export-led growth = unbalanced economy (as surplus on current account on BoP) = might not be sustainable

• Why?: interdependence (= chain of recessions)

Comparative advantage & its impacts

• When it can produce goods and services at a lower opportunity cost than another

• Increases AD

• Encourages firms to invest = improved supply-side of economy = long-term growth

CPI

A measure of inflation, reflecting average price changes for a basket of consumer goods/services.

Hyperinflation

Extremely rapid, uncontrollable rise in GPL (typically >50%/month)

3 main causes of inflation

1. Demand Pull Inflation

2. Cost Push Inflation

3. Growth of Money Supply

Demand Pull Inflation (explanation & triggers)

• Excessive increases in AD (AD rises faster than productive capacity) =

• Increased pressure on resources =

• Producers raise prices (also to achieve bigger profit margins)

Triggers:

• Lower interest rates = depreciation in exchange rate = M expensive/X cheaper = AD rise

• Low taxes/more government spending = more disposable income

• Lower interest rates = less saving = consumer spending increases

• Growth in UK export markets = M increase = AD rise

• When there is full employment of resources (when aggregate supply is inelastic)

Cost Push Inflation (explanation & triggers)

• When firms respond to rising production costs by increasing prices (to protect profit margins)

• Examples of how production costs rise: raw materials & labour e.g. through trade/workers’ unions

• Consumers may ask for higher wages = possibly more inflation

Triggers:

• Indirect/environmental taxes (on producers) = decreased AS

• Lower interest rates = depreciation in exchange rate = M expensive = decreased AS

• Monopolies = exploit consumers with high prices by decreasing supply = decreased AS

• Also little to no substitute goods/services = inelastic PED (can increase price without decreasing demand much) = can exploit consumers with high prices

• Unionisation = increased presence of trade/workers’ unions = more likely to increase wages = decreased AS

Growth of the Money Supply

• Increased disposable income but no increase in goods/services supplied = inflation

Impacts of Inflation on Consumers

• Decreased purchasing power > decreased QoL

• Decreased value of money > increased purchasing power for those in debt & decreased purchasing power for those who save

• Psychological effects: people feel less well-off > decreased spending

Impacts of Inflation/Deflation/Disinflation on Firms

• British inflation > net global inflation = X more expensive = X less competitive > X decreases > BoP towards a deficit

• Deflation > encourages people to postpone purchases (to wait for price to fall further) > saving increases > fall in demand > decreased profit > reduced business confidence > I decreases

• Interest rates increase (to counter inflation) > more expensive to invest > I decreases

• Interest rates increase > less expensive to consume > C increases

• Inflation/Deflation/Disinflation being difficult to predict > firms can’t plan for future

• Firms have to calculate new prices (e.g. changing menus/research/labelling etc.) = increased production cost > higher prices (positive feedback)

How Inflation creates inequality

• LICs: most wealth is held in cash > wealth decreases more via inflation (regressive)

• Wages might not keep up with inflation > falling real incomes

• Interest on savings lower than inflation > reduced wealth

• However, higher interest rates > hard for businesses to expand

• Rising labour costs > lower profits

• British inflation > net global inflation = X more expensive = X less competitive > X decreases > BoP towards a deficit

• Inflation being difficult to predict > firms can’t plan for future

Winners & Losers of Inflation

Winners:

• Workers with strong wage bargaining power

• Debtors if negative real interest rates

• Producers if prices rise faster than costs

Losers:

• Retired on fixed incomes

• Lenders if negative real interest rates

• Savers if real returns are negative

• Workers in low paid jobs

Why inflation is hard to predict

• Volatile global energy/food prices

• Changes in currency value

• Uncertain growth in AD

• Changes in indirect taxes