2.1.2 Inflation

Define inflation

The sustained increase in average price level of goods and services in an economy, leading to a decrease in the value of money and purchasing power

Define disinflation

When the average price level is rising but at a slower rate

Define deflation

There is a fall in the average price level of goods and services in an economy

Explain the process of how CPI is measured

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What is the importance of weights in the CPI measure

Weights are used to reflect how much households actually spend on that particular good, for example, households spend more on food than on tobacco, so the CPI should reflect that

Households spent 75% of their income on food and 25% on travel. The inflation rate of food is 8% and of travel is 4%. Calculate the inflation rate using the CPI

Inflation rate = 7%., explanation on OneNote

What are the four limitations of the CPI

Product changes not taken into account, housing costs not included, changes in spending patterns only accounted for once a year, potential sampling issues

What are the three causes of inflation

Demand-pull, cost-push, growth in the money supply

How does demand-pull inflation occur

Occurs when AD increases at a faster rate than AS

How does cost-push inflation occur

Occurs when SRAS decreases, perhaps through the cost of production increasing

How does inflation affect consumers, workers, firms and governments

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