4.3.3 Consequences of Inflation

• What is the definition of inflation?

  Sustained increase in prices
• Cost-push inflation is caused by rising production costs.


  True
• If the price of a loaf of bread rises from £1.50 to £1.80, the purchasing power decreases to 83.3%
• Inflation can reduce business profits by raising operating costs.


  True
• What is the term for profit earned after accounting for inflation?

  Real return
• What is nominal income?

  Income in current money terms
• Steps of the wage-price spiral

  1️⃣ Rising wages

  2️⃣ Higher prices

  3️⃣ Demands for higher wages

  4️⃣ Further inflation
• Inflation reduces purchasing power because the same amount of money can buy less over time.
• Inflation increases the amount of goods and services that a unit of money can buy.

  False
• How does inflation affect businesses?

  Raises operating costs
• What is the real return on a savings account with a nominal return of 2% and inflation of 4%?

  -2%
• A savings account always maintains its value during inflation.

  False
• Nominal income increases due to wage adjustments to keep pace with rising prices.
• The wage-price spiral is a feedback loop that can destabilize the economy.


  True
• How does high inflation reduce consumer spending?

  Lowers purchasing power
• Which income group is disproportionately affected by inflation?

  Low-income
• Demand-pull inflation occurs due to an increase in aggregate demand
• What is the effect of inflation on purchasing power?

  Reduces purchasing power
• How does inflation affect households?

  Increases cost of living
• Match the scenario with its real return:

  Savings Account (2% nominal return, 4% inflation) ↔️ -2% real return

  Bond Investment (5% nominal return, 4% inflation) ↔️ 1% real return
• Real income can increase, decrease, or remain stagnant depending on whether wage growth outpaces inflation
• What is real income?

  Income adjusted for inflation
• How does inflation affect households?

  Increases cost of living
• Real return is the profit after accounting for inflation.
• What is the real return on a stock investment with a nominal return of 10% and inflation of 4%?

  6%
• Match the type of income with its definition:

  Nominal Income ↔️ Income expressed in current money terms

  Real Income ↔️ Income adjusted for inflation

  Wage-Price Spiral ↔️ Rising wages increase prices, fueling inflation
• What happens to real income if wage growth is less than inflation?

  Decreases
• High and persistent inflation can negatively impact economic growth.
• Match the economic impact with its explanation:

  Uncertainty and Volatility ↔️ High inflation makes planning difficult

  Erosion of Savings ↔️ Inflation reduces real value of investments

  Wage-Price Spiral ↔️ Self-perpetuating cycle of rising wages and prices
• Inflation exacerbates wealth inequality in society.


  True