Inflation

• What is inflation?

  A sustained rise in the general price level mainly caused by economic growth
• What is deflation?

  A sustained fall in the general price level mainly caused by economic recession
• What is disinflation?

  A fall in the rate of inflation, so the price level rises more slowly
• What is the Consumer Price Index? (CPI)

  The measure of inflation used to make international comparisons
• How is inflation rate calculated?

  Change/original x 100
• What is the main limitation of CPI as a measure of the rate of inflation?

  It does not include housing costs, which are a significant item of expenditure
• What is demand-pull inflation?

  When aggregate demand in the economy increases at a faster rate than aggregate supply
• What is cost-push inflation?

  When aggregate supply decreases, so the total costs of production increase
• What are the two main causes of demand-pull inflation?

  A decrease in interest rates, and an increase in government spending
• What are the two main causes of cost-push inflation?

  A rise in the price of raw materials, and a fall in the exchange rate
• How does inflation affect consumers with fixed incomes?

  Inflation implies their incomes would fall in terms of real GDP
• How does inflation affect consumers with savings?

  If the rate of inflation is higher than the interest rates on savings, the real value of them will decrease
• How does inflation affect consumers with loans or mortgages?

  If the rate of inflation is higher than the interest rate on loans, the real value of them will decrease
• How does inflation affect firms with a fall in exports?

  If a country's rate of inflation is higher than any of its trading partners, their international competitivness will decrease
• How does inflation affect firms in terms of uncertainty?

  A high rate of inflation might make it dificult for firms to set budgets, which will result in a decrease in investment
• How does inflation affect firms in terms of lower profits?

  Cost-push inflation is likely to result in a decrease in profits which could result in a decrease in investment
• How does inflation affect firms in terms of impact on monetary policy?

  High inflation rates might cause the Monetary Policy Committee (MPC) to increase interest rates
• How does inflation affect the governement in terms of a fall in the real value of national debt?

  Inflation would reduce the value of debt owed by the government, meaning it would be less of a burden
• How does inflation affect the government in terms of increased inequality?

  Inflation might make it more dificult for the governement to reduce income inequality because those on fixed salaries will see a decrease in the real value of them
• How does inflation affect the government in terms of a deterioration in the balance of trade?

  If inflation causes a fall in the country's international competitivness, exports are likely to decrease and imports will increase, leading to deterioration in the trade balance
• How does inflation affect workers in a weak bargaining position?

  If inflation rises at a faster rate than wages increase, workers would see their living standards decrease
• How does inflation affect workers in terms of unemployment?

  A very low rate of inflation might imply a low level of demand in the economy and a high rate of unemployment