Inflation

define inflation

general and sustained rise in the price level of goods and services in the economy, resulting in a decrease in the purchasing power

define deflation

general and sustained fall in the price level of goods and services in the economy, resulting in an increase in purchasing power

define disinflation

a decrease in the rate of inflation (the general price level is still rising but at a slower rate than before)

What are the types of inflation

Cost-push inflation

Demand-pull inflation

Explain cost-push inflation

Changes in the supply side of the economy (cost of production rising) leads to prices of goods rising (firms pass on cost increases to maintain their profit margins)

What affects costs of production

• wages

• raw materials

• productivity

• taxes

• subsidies

• natural disaster

• exchange rate changes

Explain demand-pull inflation

• Commonly described as ‘too much money chasing too few goods’

• Increasing demand for goods and services puts pressure on the factors of production and production capacities

• upward pressure on prices

What are the components of AD

• Consumption

• investment

• gov.t spending

• net exports

How can inflation lead to wage price spiral

• Inflation leads to real wages falling

• when they become unstuck workers request higher wages to compensate

• firms cost of production increases

• firms raise their prices

• further inflation

• process repeats

What is stagflation

When SRAS shifts inwards so you get stagnant growth and a rise in the price level

What’s one cause of inflation

growth of the money supply

What is quantitative easing

the Bank of England printing a set amount of new money and using it to purchase government bonds held by commercial banks, making them more liquid and thus increasing the amount of money in circulation

How can the money supply increase

quantitative easing

How can quantitative easing cause inflation

if the money supply grows at a faster rate than the growth in real output

Give me an example of hyperinflation occurring in history

Germany 1923 after the First World War, they printed more money to pay workers and recover but this got out of hand an inflation rate exploded

What do we use to calculate inflation

Consumer Price Index (CPI)W

Why is CPI a better way of calculating inflation compared to the GDP deflator

CPI measures the change in the PL of a ‘typical’ basket of CONSUMER goods

GDP deflator considers the price of goods and services purchased by businesses and governments, not just by consumers, so is less representative measure of inflation to consumers

How does the CPI work

prices are monitored around 750 items across 140 locations to account for price differences (e.g. London is more expensive)

The 750 items change year-on-year dependant on changing consumer preferences

The price of each item is calculated and the proportion of income spent on them

How often are the prices of goods updated

on a monthly basis

What is the formula for CPI

CPI = ( Cost of basket in current period / Cost of basket in base period ) x 100

What is the value of CPI in the base period typically

100

How is CPI expressed

As an index number to simplify complicated comparisons

How can we use CPI to calculate the inflation rate

Current CPI - Past CPI / Past CPI = inflation rate

What are the limitations of CPI

1. Misrepresentative of some consumers - not everyone purchases the ‘typical’ basket of goods

2. Difficult of past comparisons - the basket used to calculate CPI changes year-on-year for consumer preferences making it hard to compare years

3. Habits change in under a year - CPI is calculated monthly but the typical basket only annually so preferences may alter within that time

4. Substitutes - if one good goes up in price consumers buy a cheaper substitute which may not be included in the typical basket until its updated

What is an alternative measure of inflation to CPI

Retail Price Index (RPI)

What is retail price index

measures the change in average prices for a basket of goods to measure inflation

How is CPI different to RPI

1. It uses a different formula

2. takes into account council tax

3. takes into account mortgage payments

4. basket of goods used is slightly different

Why might RPI give a higher rate of inflation than CPI

as it takes into account housing costs which usually increases at a relatively high rate

How does inflation impact consumers

How does inflation impact firms

How does inflation impact the government