Inflation

• Inflation

  The persistent increase in the general price level in an economy in a year
• Demand pull inflation

  When the demand for goods and services is more than the economy is able to supply. AD shifts out leading to an increase in the price level
• Cost push inflation

  When the increase in cost of production reduces supply. SRAS shifts in and price level increases
• Index number formula


  Index = Current year / Base year x 100
• CPI

  Consumer price index is a basket of common goods that is used to measure inflation
• Calculating CPI process

  A house expenditure survey is carried out by the ONS.

  650 of the most common and popular goods and services forms the common basket of goods.

  This represents the avarage spendings of a household.

  A price survey is carried out which finds the avarage prices of these goods and services

  Weights are established based on the proportion of income that goes towards specific goods and services and a weighted avarage of all the prices finds the price level
• Disadvantage of CPI: unusual spending habits

  Some people with unusual spending habits for example, excessive travelling may not be represented by the avarage increase in price level as their spendings may not be in the basket of goods
• Disadvantage of CPI: Time lag

  The CPI basket is only updated once every year which isn't representitive of spending habits as it may not include new goods and services which recently became popular
• Disadvantages of CPI: Changes in quality

  CPI may increase which would suggest goods and services are getting more expensive however people may just be buying higher quality products. For example newer phones
• Disadvantages of CPI: Housing costs

  The CPI doesn't include housing costs for example, rent and mortgages which take up a large proportion of a households income
• Deflation

  The persistant decresae in general price levels in an economy in a year
• Two types of deflation

  Demand side deflation (malignant) and Supply side (Benign)
• Types of deflation

  Malignant is bad, anticipated deflation.

  Benign is good, unanticipated deflation.
• Deflationary spiral

  Deflation occurs which causes consumers to delay spendings in anticipation of lower price. This decreases consumption and AD which decreases the price level and the cycle repeats, decreasing output and real GDP
• Why is anticipated deflation bad

  Consumers will delay spendings in anticipation of lower prices which reduce Consumption, reduces profit and could cause more unemployment and less real GDP due to AD shifting in
• Why is unanticipated deflation good

  Consumer will spend more due to falling prices that are not anticipated. Firms cost of production decreases which shifts out SRAS and increases Real GDP
• Effects of inflation: Wage-consumer price spiral

  If workers anticipate high inflation rates, they may demand for higher wages in order to keep up with the cost of living. This would shift SRAS left and would result in a higher price level. This could lead to hyperinflation
• Acronym to remember CPI disadvantages

  CHUT
• Effects of inflation: Reduces the real value of debt

  Inflation reduces the value of money and a debt is a fixed value so this reduces the real value you have to pay back
• Effects of inflation: Reduced value of savings and wages

  Inflation reduces the value of money and when this occurs, workers on fixed wages are worse off and the value of savings is reduced
• Effects of inflation: Lowers costs

  Workers on fixed wages would help reduce costs for firms and the governemnt as their real wages would decrease
• Effects of inflation: Decrease in investemnt

  Unstable inflation can reduce investment because it becomes more risky as there is more uncertainty
• Inflation target

  2% plus or minus 1%
• Cost of inflation

  Lower purchasing power which results in a higher cost of living
• Cost of inflation

  Reduces export competition
• Cost of inflation

  Wage/consumer price spiral
• Beneift of inflation

  Gives workers wage bargining rights
• Benifit of inflation

  Can reduce unemployment
• Beneift of inflation

  Reduces the real value of debt
• Benenift of inflation

  Improves government finances
• 5 main costs of inflation

  Shoe leather costs

  Menu costs

  Income redistribution problems

  Labour market problems

  Export competitivness