Inflation

• How is inflation defined?

  Change in overall average price level
• What is the most important measure of general prices in the UK?

  Consumer Price Index (CPI)
• What does the Consumer Price Index (CPI) assess?

  The 2% inflation target
• Why is CPI not the same as inflation?

  Inflation is the rate of change in prices
• How often is the CPI measured?

  Every month
• What does an increase in CPI indicate?

  It indicates inflation
• What is the Retail Price Index (RPI)?

  An alternative measurement of inflation
• How does RPI differ from CPI?

  RPI includes mortgage repayments
• What does the rate of inflation show?

  Price changes compared to the same month last year
• If a bundle of goods costs £100 in October 2013 and £102 in October 2014, what is the rate of inflation?

  2%
• What inflation target has the government set?

  2% +/- 1% (1% - 3%)
• Who is responsible for achieving the inflation target?

  The Bank of England
• What happens if the Bank of England fails to meet the inflation target?

  The Governor must explain to the Chancellor
• What is cost-push inflation?

  Inflation from increased costs faced by firms
• What can cause cost-push inflation?

  Increased oil prices or wage costs
• How does demand-pull inflation occur?

  From an increase in aggregate demand
• What are the effects of demand-pull inflation as aggregate demand approaches full employment?

  • Rate of inflation increases
  • AS curve becomes steeper
  • More significant impact on prices
• What factors influence the persistence of price level increases?

  • One-off increases in demand components
  • Continuous shifts in aggregate demand
• Why is low inflation important for international competitiveness?

  It keeps UK goods/services affordable
• How does high inflation affect business confidence?

  It makes investment predictions difficult
• What can low inflation allow the Bank of England to do with interest rates?

  Lower interest rates to stimulate the economy
• What are menu costs?

  Costs from changing prices frequently
• How does high inflation distort normal economic behavior?

  It discourages holding money due to value erosion
• What happens to real income during high inflation?

  It can decrease if wages don't keep up
• What is a wage-price spiral?

  Higher inflation leads to higher wage demands
• What is inflationary noise?

  • Confusion between specific price increases and general inflation
  • Can cause unrest and lack of confidence
• What is deflation?

  When the general price level is falling
• What can cause deflation?

  A fall in aggregate demand or increase in supply
• How does delayed consumption relate to deflation?

  Consumers wait for cheaper prices in the future
• Why do firms reduce investment during deflation?

  Falling prices imply falling profits
• What is disinflation?

  • A decrease in the rate of inflation
  • A slowdown in price level increases
• What can happen if disinflation continues with low inflation rates?

  It can lead to actual deflation
• What happens if the money supply increases by 4%?

  It can lead to a 4% increase in AD
• What occurs if AD increases by 4% and LRAS also increases by 4%?

  No inflation, just an increase in real output