Inflation Summary Notes

Definition

  • Inflation: persistent rise in the general price level of goods & services over time
  • Measured as % change, usually via Consumer Price Index (CPI)

Measurement (CPI)

  • Select basket of commonly purchased goods & services
  • Collect prices regularly
  • Choose base year, set index at 100100
  • Calculate average price change → inflation rate
  • Example: CPI 100→103100 \to 103 ⇒ inflation 3%3\%

Types of Inflation

  • Demand-Pull: excess aggregate demand (AD > AS)
    • Drivers: ↑ consumer spending, ↑ government spending, ↓ interest rates, ↑ exports
  • Cost-Push: rising production costs passed to prices
    • Drivers: ↑ wages, ↑ raw material costs (e.g., oil), ↑ indirect taxes (e.g., VAT)

Consequences

  • Consumers: lower purchasing power (esp. fixed incomes)
  • Savers: real value of savings falls
  • Workers: demand higher wages; if unmet, ↓ living standard
  • Firms: cost uncertainty, ↓ competitiveness
  • Government: pressure to raise wages/pensions, potential loss of popularity

Controlling Inflation

  • Monetary policy: ↑ interest rates, restrict money supply → ↓ demand
  • Fiscal policy: ↑ taxes or ↓ government spending → ↓ aggregate demand
  • Supply-side policies: boost productivity, cut production costs, increase competition

Key Definitions

  • Inflation: persistent rise in general price level
  • CPI: index of average price changes in basket of goods
  • Real income: nominal income adjusted for inflation
  • Hyperinflation: extremely high, uncontrolled inflation
  • Disinflation: falling inflation rate (still > 00)
  • Deflation: negative inflation (general price level falls)

Quick MCQ Tips

  • CPI always based on a basket of goods
  • ↑ interest rates → likely ↓ inflation
  • Demand-pull linked to high consumer demand
  • Cost-push linked to rising wages/input prices
  • Inflation erodes real value of money