Inflation

• What is inflation?

  Inflation is a sustained increase in the average price level of an economy. The rate of inflation is measured by the annual percentage change in the level of prices as measured by the consumer price index. A sustained fall in the general price level is called deflation – in this situation, the rate of inflation becomes negative.
• Why is the Rate of Inflation in the UK So Low Recently?

  -Falling global commodity prices including oil

  -Slow wage growth in the labour market

  -Falling food prices

  -Sustained price deflation in technology products

  -Slower real economic growth – falling towards 2%

  -Still some spare capacity on the supply-side of the economy
• Causes of Inflation

  -Too much demand - Businesses respond to high demand by raising prices to increase their profit margins. Excess demand in the economy or a market is associated with the boom phase of the business cycle

  -Rising business costs - External shocks. A depreciation in the exchange rate. Faster growth in wages and salaries
• The main costs and consequences of inflation

  -Money loses its value and people lose confidence in money as the value of savings is reduced

  -Inflation can get out of control - price increases lead to higher wage demands as people try to maintain their living standards. This is known as a wage-price spiral.

  -Consumers and businesses on fixed incomes lose out because the their real incomes falls - employees in poor bargaining positions lose out
• The main costs and consequences of inflation

  -Inflation can disrupt business planning and lead to lower capital investment

  -Inflation is a possible cause of higher unemployment in the long term – because of a lack of competitiveness

  -Inflation is a possible cause of higher unemployment in the long term – because of a lack of competitiveness

  -Rising inflation is associated with higher interest rates - this reduces economic growth and can lead to a recession
• Inflation and price elasticity of demand

  -Remember that price elasticity of demand refers to the responsiveness of demand to changes in price

  -When demand is inelastic, a price rise leads to a less than proportionate fall off in quantity demanded

  -When demand is elastic, a price rise leads to a more than proportionate fall off in quantity demanded

  -Businesses with products that have inelastic price elasticity of demand will be less affected by a rise in inflation
• inflation and elasticity of demand

  -Some businesses will be able to absorb price increases by becoming more efficient

  -Price inflation will vary from industry to industry – be careful about making generalisations