Inflation

Inflation

A sustained increase in general price level

Hyperinflation

Refers to very high and increasing inflation, typically it has to be at least above 50% 

Cause of inflation

demand pull, cost push

Deflation

A sustained decrease in the general price level

deflationary spiral

The spiral begins with deflation which is where there is a sustained fall in the general price level. Consumers notice the falling prices and decide to delay their purchases and wait for prices to fall further. This causes a reduction in AD as consumption is a component of AD. The fall in AD lowers the price level again and so consumers further delay their purchases. And the cycle repeats.

Cause of deflation

decrease in AD, increase in SRAS

Inflation and change in value of money

Inflation leads to the value of money decrease

Deflation leads to the value of money increase

Nominal income

the amount you actually earn.

real income

how much your income is actually worth in terms of the amount of goods that you can purchase.

Nominal income with the effects of inflation removed

Inflation rate

% change in price level

three stages to calculating the UK’s price level

Stage 1 - the Office of National Statistics conducts its Living Costs and Food Survey. This involves interviewing 7000 households to find the 650 most common goods and services and to find the percentage of their spending goes on each of these goods and services.

Stage 2 - the ONS conducts a price survey where they collect prices of these 650 goods from across the UK in order to find the average price of each good.

Stage 3 - a weighted average of all the prices is calculated in order to find the price level.