Inflation

• What is inflation?

  A sustained rise in the general price level
• How does inflation affect purchasing power?

  It causes a parallel fall in purchasing power
• What is the UK government's target for inflation?

  2%
• What is the role of the Bank of England regarding inflation?

  To use monetary policy to meet the inflation target
• What is the effect of constant small increases in production costs?

  It gives firms confidence to invest
• What is deflation?

  A decrease in the general price level
• How does deflation differ from a falling rate of inflation?

  Deflation means prices are actually falling
• What happens during deflation regarding consumer behavior?

  Households delay purchases expecting lower prices
• What is disinflation?

  A fall in the rate of inflation
• How does disinflation manifest in price changes?

  Prices are still rising but at a slower rate
• What is hyperinflation?

  Rapidly accelerating inflation that becomes uncontrollable
• What happens to money during hyperinflation?

  Money becomes worthless
• What are the two principal measures of inflation in the UK?

  Consumer Prices Index (CPI) and Retail Prices Index (RPI)
• Which inflation measure does the UK government prefer?

  The Consumer Prices Index (CPI)
• What is the first step in constructing the official measure of inflation in the UK?

  Carry out the family expenditure survey
• How many goods and services are in the average basket for inflation measurement?

  About 700 goods and services
• What does the weighted average price measure?

  The frequency of purchase of different goods
• What is the base number used when converting data into an index?

  100
• How do index numbers help economists?

  They make comparisons over time easier
• How do you calculate the percentage change using index numbers?

  Change/original x 100
• What does an index number of 102 indicate?

  A 2% rise from the base period
• What does an index number of 98 indicate?

  A 2% fall from the base period
• What are chain base numbers?

  Changes between years calculated similarly
• What are the advantages and disadvantages of using CPI and RPI to measure inflation?

  Advantages:

  • Standard government measure for comparison
  • Yearly review of expenditure changes
  • CPI allows international comparisons

  
  

  Disadvantages:

  • No average household exists
  • CPI excludes mortgage payments
  • CPI and RPI do not reflect quality improvements
  • Special offers are not included
  • Sampling errors may occur
• What are the two main causes of inflation?

  Demand Pull and Cost Push
• What is demand-pull inflation?

  Inflation caused by excessive demand
• What happens when demand grows faster than supply?

  Prices will increase
• What fuels demand-pull inflation?

  Excessive consumption and low interest rates
• What is cost-push inflation?

  Inflation caused by excessive costs
• What happens when firms' costs go up?

  Firms increase their prices to maintain profits
• What can cause costs to rise for firms?

  Increases in wages and higher taxes
• What is the Fisher equation of exchange?

  MV = PQ
• What does the Fisher equation suggest about the money supply?

  Increasing money supply causes inflation
• What happens when the money supply increases?

  Consumers have more money to spend
• What is a consequence of increased demand due to higher money supply?

  AD shifts to the right
• What happens to wages as a result of inflationary pressure?

  Wages increase as more workers are employed
• What is a consequence of inflation on real money value?

  The real value of money falls
• What can happen to demand as inflation rises?

  There can be a contraction in demand
• What are expectations in the context of inflation?

  They influence future inflation rates
• How can supply-side shocks affect inflation?

  They can increase domestic inflation rates