2.1.2 Inflation

• Inflation is defined as the sustained increase in the general price level of goods and services in an economy
• Cost-push inflation results in reduced output.
• Demand-pull inflation occurs when excess aggregate demand exceeds supply
• Steps in the wage-price spiral

  1️⃣ Rising wages

  2️⃣ Higher prices

  3️⃣ Increased wage demands

  4️⃣ Further higher prices
• What type of inflation arises from increased prices of imported goods?

  Imported inflation
• Match the type of inflation with its primary cause:

  Cost-push inflation ↔️ Increase in production costs

  Demand-pull inflation ↔️ Excess aggregate demand

  Wage-price spiral ↔️ Rising wages and prices

  Imported inflation ↔️ Increase in import prices
• Cost-push inflation occurs when production costs increase
• What is one example of a government action that can cause demand-pull inflation?

  Increased government spending
• The wage-price spiral is a self-reinforcing cycle of rising wages and prices.
• The wage-price spiral begins when rising wages lead to higher prices
• What is one effect of imported inflation on domestic prices?

  Higher domestic prices
• Steps in the cost-push inflation process

  1️⃣ Increased production costs

  2️⃣ Higher business expenses

  3️⃣ Higher prices of goods
• Which type of inflation involves a reinforcing cycle of rising wages and prices?

  Wage-price spiral
• Higher import prices can result from currency depreciation
• What is imported inflation caused by?

  Higher import prices
• Inflation arises from a combination of cost pressures and demand imbalances in the economy.
• Two main indices used to measure inflation are the CPI and the RPI
• What type of mean is used in the CPI formula?

  Geometric mean
• The CPI is generally preferred because it accounts for substitution effects.
• Inflation is a sustained increase in the general price level of goods and services
• Match the type of inflation with its cause:

  Cost-Push Inflation ↔️ Increased production costs

  Demand-Pull Inflation ↔️ Excess aggregate demand

  Imported Inflation ↔️ Higher import prices
• What does 'C' stand for in the aggregate demand formula?

  Consumption
• The relationship between aggregate demand and its components is expressed as AD = C + I + G + (X - M)</latex>
• The CPI uses an arithmetic mean, which can lead to higher inflation rates.

  False
• What is the formula for the real interest rate?

  r_{\text{real}} = r_{\text{nominal}} - \pi</latex>
• Monetary policies to control inflation include raising interest rates and reducing the money supply
• What is an example of a fiscal policy to control inflation?

  Increasing taxes
• Supply-side policies reduce cost-push inflation by improving productivity and efficiency.