2.1.2 Inflation

• What is inflation?

  Sustained increase in average price level
• What does inflation indicate about money value?

  It indicates a decrease in money's value
• What is deflation?

  Decrease in average price level
• What is disinflation?

  Decrease in the rate of inflation
• What does CPI stand for?

  Consumer Price Index
• Why is CPI important?

  It measures inflation for government policies
• What are the importance of inflation?

  • Decides interest rates
  • Influences pensions and benefits
  • Affects business pricing and wages
  • Impacts currency exchange rates
• What does the Family Expenditure Survey measure?

  Household purchasing power and spending
• How is the basket of goods for CPI created?

  Based on consumer spending patterns
• Why does petrol have a higher weighting than tea in CPI?

  More income is spent on petrol
• How often is the basket of goods updated?

  Each year
• What are the limitations of CPI?

  • Averages affect individuals differently
  • Ignores regional price differences
• What does RPI stand for?

  Retail Price Index
• How does RPI differ from CPI?

  RPI includes housing costs
• Why does RPI tend to have a higher value than CPI?

  RPI includes housing costs like mortgages
• Who does RPI exclude?

  Top 4% earners and low-income pensioners
• What does CPI account for that RPI does not?

  Consumer switching to cheaper products
• What are the causes of inflation?

  • Demand Pull Inflation
  • Cost Push Inflation
  • Growth of the money supply
• What is Demand Pull inflation?

  Too much demand with insufficient capacity
• What can cause excess demand?

  Decrease in income tax increases disposable income
• How do lower interest rates affect demand?

  They increase disposable income and spending
• What happens when the exchange rate depreciates?

  Imports become more expensive, exports cheaper
• What is Cost Push inflation?

  Higher costs for firms lead to price increases
• What can cause an increase in costs for firms?

  Higher wages achieved by trade unions
• How can a fall in exchange rate affect costs?

  It can increase the cost of imports
• What effect do indirect tax increases have?

  They increase costs for businesses
• What happens if the Bank of England prints more money?

  More money flows in the economy
• What is hyperinflation?

  Extremely high and uncontrollable inflation
• When is an increase in money supply inflationary?

  If it exceeds the rate of real output
• What does the equation M x V = P x Y represent?

  Relationship between money supply and output
• What does M represent in the equation?

  Total money in the money supply
• What does V represent in the equation?

  Number of times money circulates
• What does P represent in the equation?

  Average level of prices
• What does Y represent in the equation?

  Output of goods and services
• How does inflation affect consumers?

  • Hits low and fixed income hardest
  • Decreases purchasing power of money
  • Reduces real value of debt for borrowers
• How does inflation affect firms?

  • Low interest rates encourage borrowing
  • High inflation raises investment costs
  • Unpredictable inflation reduces business confidence
• How does inflation affect the government?

  • Increases state pension and welfare payments
• How does inflation affect workers?

  • Real incomes fall with inflation
  • Less disposable income for workers
  • Potential for redundancies due to higher costs