2.1: Inflation

• What is inflation?

  A sustained increase in the average price level of goods in an economy
• How is the average price level measured?

  By checking the price of a basket of goods that an average household would purchase monthly
• What is Deflation?

  When there is a fall in the average price level of goods
• What is Disinflation?

  A rise in the general price level, but at a slower rate
• What is Hyperinflation?

  A rise in the general price level by more than 50% monthly
• What does inflation indicate about the economy?

  Indicates a rise in the cost of living
• What are the causes of inflation?

  Changes to wages, changes to money supply, demand-pull inflation, and cost-push
• What is Demand pull inflation?

  Inflation caused by excess demand
• What is cost push inflation?

  Inflation caused by an increase in the costs of production
• Aggregate demand

  Sum of all expenditure in the economy (Consumption, Investment, Government spending and Net exports)
• Short-run aggregate supply (SRAS)

  Total supply provided in the economy at a given average price level
• What happens if the Central Bank lowers interest rates ?

  There will be increased borrowing by firms and consumers. Increase in Consumption and Investment. Demand-pull inflation.
• What happens if the Central Bank increases the money supply?

  Increased liquidity and lower interest rates. Demand-pull inflation.
• What is Wage-Price spiral?

  Increased aggregate demand results in demand-pull inflation, demand-pull inflation results in increase in cost of living, which makes workers demand better wages. Increased wages result in cost-push inflation as there's an increase in costs of production for firms, which result in even higher prices.
• Effects of inflation on consumers

  Decrease in purchasing power, decrease in real value of savings, decrease in real value of income.
• Effects of inflation on governments

  Trade-offs involved in tackling inflation (decreasing inflation may increase unemployment or reduce GDP). Decreased international competitiveness of export industries.
• Effects of inflation on firms

  Rising costs, business expansion is hard due to increase in interest rates,
• Consumer Price Index

  Index that measures inflation in the UK
• How is CPI measured?

  'household basket' of 700 goods/services that an average family would purchase is compiled on an annual basis

  •  A household expenditure survey is conducted to determine what goes into the basket
• How are goods in the basket weighed?

  Based on the proportion of household spending
• What determines the final value of the good in the basket?

  The price multiplied by the weighting
• CPI formula

  Cost of basket in a certain year divided by Cost of basket in base year multiplies by 100
• Percentage difference in CPI between two years

  Inflation rate
• Limitations of CPI

  Not representative (the average basket is based on assumption ), does not capture quality of goods, only measures changes on an annual basis
• Retail price index

  Measures inflation by considering household costs
• Why is inflation measured by RPI higher than CPI?

  Due to extra inclusions and argued accurate measurement of household inflation.