Measuring, Causes, Consequences, and Policies of Inflation

Vocabulary practice flashcards covering measuring inflation, causes, consequences, and control policies according to the CIE IGCSE Economics syllabus.

Inflation

The sustained increase in the general price level of goods and services in an economy.

General Price Level

The average price measure obtained by checking the prices of a weighted 'basket' of goods and services that an average household purchases each month.

Consumer Price Index (CPI)

An index compiled annually using a weighted household basket of $700+$ goods and services to measure changes in the general price level.

Deflation

A fall in the general price level of goods and services in an economy, which occurs when the percentage change in prices falls below $0\%$.

Disinflation

A reduction in the inflation rate (e.g., from $5\%$ to $3\%$), meaning prices are still rising but at a slower rate.

Inflation Target

An economic target set by most economies at $2\%$ per annum, as low inflation is considered a sign of economic growth.

CPI Basket Weighting

The assignment of importance to goods and services in the CPI basket based on the proportion of total household expenditure spent on them.

CPI Calculation Formula

$$\text{CPI} = \frac{\text{Cost of basket in year X}}{\text{Cost of basket in base year}} \times 100$$

Inflation Rate Calculation Formula

$$\text{Inflation rate} = \frac{\text{New CPI} - \text{Old CPI}}{\text{Old CPI}} \times 100$$

Demand-pull Inflation

Inflation caused by excess total (aggregate) demand in the economy when any component of total expenditure increases.

Components of Aggregate Demand (rGDP)

The four expenditure components summing to total demand: Consumption ($C$), Investment ($I$), Government spending ($G$), and Net Exports ($X - M$).

Cost-push Inflation

Inflation caused by increases in the costs of production (such as higher wages or raw materials) or a fall in productivity, decreasing total supply.

Demand-pull Inflation Diagram

A macroeconomic model illustrating an increase in aggregate demand from $\text{AD}_1$ to $\text{AD}_2$, shifting the equilibrium average price level upwards from $\text{AP}_1$ to $\text{AP}_2$.

Cost-push Inflation Diagram

A macroeconomic model illustrating a reduction in short-run aggregate supply from $\text{SRAS}_1$ to $\text{SRAS}_2$, shifting the equilibrium average price level upwards from $\text{AP}_1$ to $\text{AP}_2$.

Imported Inflation

An external cause of inflation arising when global prices for imported goods, fuel, or raw materials rise, or when a weaker exchange rate makes imports more expensive.

Menu Change Costs

The explicit costs incurred by businesses when changing prices repeatedly during periods of inflation.

Purchasing Power

The quantity of goods and services that a unit of currency can buy, which decreases during periods of inflation.

International Competitiveness

The relative price attractiveness of a country's exports abroad, which is eroded by high domestic inflation.

Government Debt Erosion

A beneficial consequence of inflation for governments, as rising price levels decrease the real value of national debt repayments.

Effect of Inflation on Savers

Savers lose out during inflation because the real purchasing power of saved money falls over time as prices rise.

Effect of Inflation on Lenders

Lenders lose out during inflation because money repaid to them in the future is worth less in real terms than when lended.

Effect of Inflation on Borrowers

Borrowers gain during inflation because they repay loans using money that has less real purchasing power than when originally borrowed.

Contractionary Fiscal Policy

A demand-side policy aimed at reducing demand-pull inflation by increasing taxes (e.g., corporation or income tax) or reducing government spending.

Contractionary Monetary Policy

A demand-side policy used by central banks to control inflation by increasing interest rates or decreasing the money supply (e.g., stopping quantitative easing).

Supply-side Policies for Inflation

Long-term policy measures (e.g., deregulation, migration policy changes, or infrastructure projects) designed to reduce costs of production and increase total supply.