Inflation (LS8)

Question 1

CPI definition

Answer 1

Measures the average change in the price level of a weighted basket of goods and services over time

Question 2

How is cpi calculated

Answer 2

Households expenditure survey conducted
Representative + weighted basket of goods and/s is created (updated yearly )
Items in basket are weighted on the proportion of income they take up to buy
Prices of basket items are tracked over time to calculate the average price change

Question 3

What is the uk’s inflation target

Answer 3

2% plus minus 1
This target aims to maintain price stability

Question 4

RPI

Answer 4

Retail price index
Measure of inflation that tracks the average change in the prices of a basket of g/s over time, including housing costs like mortgage interest payments + council tax
Alternative measure of inflation

Question 5

RPI key points

Answer 5

Included housing costs
More representative for homeowners
Usually shows a higher rate of inflation than cpi

Question 6

CPI limitation 1- different spending patterns

Answer 6

Basket of g/s only reflects average household. Not every household will be buying the things in this basket

Question 7

CPI limitation 2- housing costs

Answer 7

CPI excludes owner-occupiers’ housing costs, not actually showing what they spend their income on

Question 8

CPI limitation 3- quality changes

Answer 8

Prices may rise due to an increase in quality of g/s in the basket. This could make the inflation seem worse than it actually is

Question 9

CPIH

Answer 9

CPI but includes owner occupiers’ housing costs

Question 10

Demand pull inflation

Answer 10

Occurs when AD grows faster than AS, causing upward pressure on prices

Question 11

Characteristics of demand pull inflation

Answer 11

Demand side of economy
Often occurs when economy is close to full employment
Firms raise prices due to excess demand

Question 12

Causes of demand pull inflation

Answer 12

Depreciation of exchange rate- net exports rise so AD rises
Fiscal stimulus- lower taxes increase disposable income, higher gov spending increases AD
Lower interest rates- higher consumption
Growth in export markets

Question 13

Demand pull inflation graph

Answer 13

Question 14

Cost push inflation

Answer 14

Occurs when firms experience rising costs of production, leading to higher prices

Question 15

Characteristics of cost push inflation

Answer 15

Supply side of economy
Occurs even when demand isn’t increasing
Firms pass higher costs onto consumers in the form of higher prices

Question 16

Causes of cost push inflation

Answer 16

Rising raw material prices
Rising wage costs (maybe due to trade union pressure)
Increased taxes
Depreciation of the exchange rate (increased import costs + other raw materials)
Inflation expectations leading to wage price spirals

Question 17

What are wage price spirals

Answer 17

When workers demand higher wages to counter inflation
Increases costs for firms so they increase their priced to maintain profits
This worsens inflation
Cycle continues

Question 18

Cost push inflation graph

Answer 18

Question 19

Why may deflation reduce consumer spending

Answer 19

Ppl delay purchases expecting prices to fall further

Question 20

What is the growth of the money supply (also cause of inflation)

Answer 20

Happens when central bank makes new money + injects it into economy
Aka quantitive easing
More money in the economy = more spending
But if output doesn’t rise at the same rate then inflation will occur (as more money will be chasing the same amount of goods)

Question 21

Effects of inflation on consumers

Answer 21

Less purchasing power

Benefits borrowers as the real value of debt falls. This means borrowers repay their loans with money that is worth less in real terms over time. Therefore ppl with fixed rate debt may find it easier to manage repayments

Question 22

Effects of inflation on firms

Answer 22

Higher inflation = higher interest rates = higher borrowing costs = less investment
Wage demands may rise = increases cost of production
Firms may become less internationally competitive (rising domestic costs increases price for foreigners- less demand)
Reduces business confidence + investment due to unpredictable inflation

Question 23

Effects of inflation on government

Answer 23

Increases spending on pensions + welfare (to maintain recipients real incomes) - this raises public spending + can put additional pressure on gov budgets

Can reduce real value of gov debt. Gov repays existing debt with money that is worth less in real terms over time- burden of debt falls

Question 24

Effects of inflation on workers

Answer 24

Real wage may fall if pay rise doesn’t increase too
Higher business costs may lead to redundancy
Job insecurity may increase when inflation is high -less confidence + spending