Inflation

Question 1

What is the Inflation Rate?

Answer 1

The change in average prices in an economy over a given period of time

Question 2

What are the two measures of price level?

Answer 2

• CPI

- RPI

Question 3

Why does the figures given by RPI differ to CPI?

Answer 3

• RPI uses an arithmetic mean, the Carli Index
• CPI uses a geometric mean
• RPI includes includes mortgage costs interest rate payments and council tax
• RPI excludes top 4% of incomer earners and low income pensioners as they are not typical households
• Due to housing prices rising RPI tends to have a higher rate of inflation

Question 4

What are Redistribution Effects

Answer 4

• Inflation redistributes income away from certain groups and toward other groups in the economy
• Certain groups lose some PPP and become worse off whilst others gain

Question 5

What are the effects of inflation on people who receive fixed income or wages?

Answer 5

As GPL increased they become worse off

• Workers having wage contracts, fixing their wages
• Pensioners received fixed pensions
• Landlords receive fixed rental incomes
• Individuals who receive fixed welfare payments
• Those who’s income rises less rapidly than the rate of inflation

Question 6

Who else is worse off due to inflation?

Answer 6

• Holders of cash, purchasing power of cash falls
• Savers, real value of their money decreases if rate of interest is not the same as inflation
• Lenders who give money, the money they relieve back if no interest is charged would be worth less

Question 7

Who gains due to inflation?

Answer 7

• Debtors/Borrowers, as long as interest rate is below rate if inflation then they pay back less money
• Payers of fixed incomes/wages, real value of the payments decrease
• Payers of income that increases less rapidly than the rate of inflation

Question 8

How does inflation cause uncertainty?

Answer 8

• Inability to predict inflation means you cannot predict purchasing power of money
• Firms become cautious of future plans as they cannot forecast their revenue
• Fewer investments as a result and therefore less economic growth

Question 9

How does inflation affect Menu Costs?

Answer 9

• Due to changing prices firms may have to continuously print new menus, catalogues etc
• The higher the rate of inflation, the more often firms have to print new menus and therefore incurring menu costs

Question 10

What is Money Illusion?

Answer 10

• The idea that some people may feel better when their nominal income increases despite GPL increasing at same rate or even faster
• Real income or purchasing power may have not changed or even be lower
• Leads to consumers making wrong decisions

Question 11

How does inflation affect international export competitiveness?

Answer 11

• When domestic PL increases faster than foreign PL then their exports become more expensive to foreign
• Their international competitiveness goes down
• Exports down, imports up
• Presents difficulties for the balance of payments of a country

Question 12

What is the ideal rate of inflation?

Answer 12

2-3% per year

Question 13

What is demand-pull inflation?

Answer 13

• When aggregate/total demand rises with no increase in aggregate supply (excess demand in the economy)
• Too much demand will cause PL to rise

Question 14

Why does demand-pull inflation occur?

Answer 14

• Consumer spending excessively rising, low interest rates and increased consumer confidence
• Forms may increase spending on investment, e.g needing extra capacity to respond to demand increase
• Gov increasing spending or cutting tax
• World demand for UK exports may rise due to a boom in the economy

Question 15

How does the money supply affect demand-pull inflation?

Answer 15

• Can increase inflation due to growth of the money supply
• If central banks lend more money to consumers, the money supply grows
• Consumers are more inclined to spend and therefore aggregate demand grows
• This causes inflation

Question 16

What is cost-push inflation?

Answer 16

• Inflation that occurs due to changes in the supply side of the economy
• Incurs inflation due to rising costs

Question 17

What are sources of cost-push inflation?

Answer 17

• Wages and Salaries are 50% of National Income, therefore increase in wages increases costs of production
• Imports can cause a rise in price, a boom in the world economy may push up commodity prices and therefor increase finished good price and imports
• Inelastic demand for goods can lead to firms rising prices for a higher profit margin
• Government can raise indirect tax or reduce subsidies increasing prices