Inflation and deflation

• What is inflation?


  Inflation is the sustained rise in the general price level over time.
• What happens to the cost of living during inflation?

  The cost of living increases and the purchasing power of money decreases.
• What is deflation?


  Deflation is the opposite of inflation, where the average price level in the economy falls.
• What is disinflation?


  Disinflation is the falling rate of inflation, where the average price level is still rising but at a slower extent.
• If the price level increases by 4% from 2014 to 2015, what does this indicate?

  This indicates inflation.
• What does a change from 4% to 2% in the price level signify?

  This signifies disinflation, as the price rise has slowed.
• What does a change in the price level to -3% indicate?

  This indicates deflation.
• What is the goal of deflationary government policies?

  Deflationary government policies aim to reduce aggregate demand (AD).
• What are the main causes of inflation?

  • Demand pull: Aggregate demand grows unsustainably.
  • Cost push: Firms face rising costs.
• What triggers demand pull inflation?

  Triggers include depreciation in the exchange rate, fiscal stimulus, lower interest rates, and high growth in export markets.
• How does a depreciation in the exchange rate affect inflation?

  A depreciation in the exchange rate makes imports more expensive and exports cheaper, causing aggregate demand to rise.
• How does fiscal stimulus contribute to inflation?

  Fiscal stimulus, through lower taxes or increased government spending, gives consumers more disposable income, increasing consumer spending.
• What effect do lower interest rates have on inflation?

  Lower interest rates make saving less attractive and borrowing more attractive, leading to increased consumer spending.
• What is cost push inflation?

  Cost push inflation occurs when firms face rising costs, leading to increased prices.
• What can cause rising costs for firms?


  Rising costs can be caused by changes in world commodity prices, higher labor costs, expectations of inflation, indirect taxes, depreciation in the exchange rate, and monopolies.

  
• How do expectations of inflation affect wages?

  If consumers expect prices to rise, they may demand higher wages to compensate, potentially triggering more inflation.
• How do indirect taxes affect inflation?

  Indirect taxes can increase the cost of goods, which producers may pass on to consumers, raising prices.
• How does a monopoly contribute to inflation?

  A monopoly can exploit its dominant market position to charge higher prices, contributing to inflation.
• What are the effects of inflation on consumers?

  • Low and fixed income individuals are hit hardest.
  • The purchasing power of money falls.
  • Loans become cheaper in real terms.
• What are the effects of inflation on firms?

  • Low interest rates make borrowing attractive.
  • Higher inflation may lead to higher costs of production.
  • Unpredictable inflation reduces business confidence.
• What are the effects of inflation on the government?

  • The government must increase state pensions and welfare payments.
• What are the effects of inflation on workers?

  • Real incomes fall, reducing disposable income.
  • Higher costs may lead to redundancies.
• When did the UK experience a short period of deflation?

  The UK experienced a short period of deflation in April 2015.
• What happens to the real value of money during deflation?

  The real value of money increases during deflation.
• How does deflation affect consumer spending?

  Deflation discourages spending because consumers believe goods will be cheaper in the future.
• What are the potential economic consequences of deflation?

  Deflation can lead to economic decline and increasing rates of unemployment.
• How does deflation affect the real value of debt?

  Deflation makes the real value of debt higher, making it harder for consumers to pay it off.
• What happens to spending in the economy during deflation?

  Spending in the economy falls, worsening the effects of a recession.
• How does deflation affect wages?

  Wages are likely to fall during deflation as firms make lower profits.
• What happens to growth and unemployment rates if the real interest rate increases during deflation?

  There could be lower growth and worse rates of unemployment if the real interest rate increases.
• What is the real interest rate if the nominal interest rate is 0% and the deflation rate is 5%?

  The real interest rate is 5%.
• What does the Quantity Theory of Money state?

  • Inflation occurs if the money supply increases faster than national income.
• What is Fisher's equation of exchange?

  Fisher's equation of exchange is represented as $MV =$$PQ$.
• What do the variables in Fisher's equation represent?

  M refers to the supply of money, V is the velocity of circulation, P is the price level, and Q is the quantity of real goods sold.
• What assumption does the Quantity Theory of Money make about velocity?

  The equation assumes that velocity is constant.
• What does the Quantity Theory of Money argue about the money supply?

  The theory argues that increasing the money supply causes inflation.
• What happens when the money supply increases according to the Quantity Theory of Money?

  When the money supply increases, consumers have more money to spend, causing aggregate demand to shift to the right.

  
• What is the result of increased aggregate demand in the short run?

  Firms increase supply in the short run, leading to a positive output gap, which is inflationary.
• What happens to wages as a result of inflationary pressure?

  As a result of inflationary pressure, more workers are employed, leading to increased wages.
• What is the effect of increased wages on firms?

  Increased wages lead to higher costs for firms, prompting them to raise prices.