2.1.2 Inflation

• Consumer Price Index


  Measures changes in the average cost of living for a representative household and is a weighted price index
• Cost-Push Inflation


  Inflation caused by rising costs of production either domestically or from importing raw materials at higher prices due to exchange rate depreciation.
• Creeping Inflation


  Small rises in the price level over a long period (low positive rate of inflation)
• Deflation


  A persistent fall in the price level shown by a negative rate of inflation
• Demand-Pull Inflation


  Caused by an excess of AD over AS (too much money and too few goods)
• Disinflation


  A fall in the rate of inflation that is not enough to cause deflation. Prices still rise, but at a slower rate
• Inflation

  A sustained increase in the general price level for goods and services
• Inflation Expectations

  The rate of increase of consumer prices expected by consumers. This influences spending, saving and wage bargaining
• Inflationary Pressures


  Demand and supply-side pressures that can cause a rise in the price level
• Money Supply


  The entire quantity of a country's commercial bills, coins, loans and credit.
• Price Stability


  When there is a low positive inflation rate of between 1-3% and price changes that do occur have little impact on consumer and firm decisions
• Relative Deflation


  An economy with an inflation rate which is lower than comparable economies which can lead to improved price competitiveness
• Stagflation


  A combination of slow growth and rising inflation
• Wage Price Spiral


  Workers bid for higher wages due to rising prices lowering the purchasing power of their real incomes. This can lead to cost-push inflation
• Weights


  Used when calculating a weighted CPI. The more weight an item has the greater the impact on CPI inflation.
• Unit Wage Costs


  Labour costs per unit of output
• Measuring CPI Inflation

  Consumer Price Index

  1. Household expenditure survey of 650 popular goods and services which changes to reflect consumer tastes
  2. Each item is weighted to show its proportion of household expenditure
  3. Data on price changes is collected monthly
  4. The weighted average price for the basket is found and is adjusted to an index figure compared to a base year
  5. The change between the current month and last year is calculated
• Limitations of CPI

  -Only accounts for certain goods so not completely representative

  -Does not include housing prices

  -Difficult to make historical comparisons

  -Overestimates inflation as prices increase due to quality
• RPI (Retail Price Index)


  Measures inflation in terms of housing costs excluding the top 4% of earners and low income pensioners
• Causes of Cost-Push Inflation

  -Cost of raw materials

  -Taxes

  -Depreciation of exchange rates

  -Cost of labour
• Growth of Money Supply


  Increased access to money, but no increase in goods and services supplied means prices must rise
• Impact of Inflation on Consumers


  -Loss of purchasing power so lower living standards

  -Debt is cheaper to pay

  -Precautionary saving
• Impact of Inflation on Firms


  -Relative inflation makes goods less competitive

  -Deflation causes people to postpone purchases so demand falls

  -Difficult to predict

  -Shoe leather costs from calculating and changing prices
• Impact of Inflation on Governments

  Governments must change excise tax to match inflation to generate the same amount of tax revenue
• Shoe Leather Costs


  The time and effort people take to minimise the effect of eroding purchasing power
• Menu Costs 


  The costs of changing price tags or menu prices in line with inflation
• Delayed Consumption 


  When there is deflation consumers delay purchases expecting prices to fall more so consumption decreases