4.2.3.3 Inflation and deflation

Inflation

A persistent or continuing rise in the average price level

Deflation

A continuin tendency for the average price level to fall

Disinflation

The rate of inflation is falling

Consumer price index

Official measure to calculate the rate of consumer price inflation

Demand-pull inflation

Rising price level caused by an increase in AD

Cost-push inflation

A rise in the price level caused by an increase in the cost of production

Monetarism

An increase in the money supply results in inflation

Quantity theory of money

Inflation caused by a persistent increase in the supply of money

Inflationary expectations

What people expect inflation to increase to in the future

Benign deflation

A fall in the price level due to increases in AS

Malevolent deflation

A fall in the price level due to a fall in AD

Short-run Phillips curve

Shows the inverse relationship between unemployment and inflation

Long-run Phillips Curve

How in LR the economy will move to the NAIRU regardless of the rate of inflation

Non-accelerating inflation rate of unemployment (NAIRU)

Where the rate of unemployment is consistent with the rate of inflation

How does demand-pull inflation occur?

High levels of spending signal to firms to increase output

As firms get closer to capacity, the higher spending will lead to firms increasing their prices as they incur higher costs in producing more output

Eventually, as the economy operates on the vertical LRAS, an increase in output will only lead to further inflation.

How can demand-pull inflation be reduced?

By reducing aggregate demand

How does cost-push inflation occur?

Where costs of production increase, this will reduce business profit margins.

Firms will then increase prices to increase their profit margins, thus increasing inflation.

What does a falling exchange rate mean for cost-push inflation?

More expensive for firms to buy foreign currency, increasing the cost of production and furthering cost-push inflation