Unit 4.6 - Price stability

• Price stability


  A low and stable inflation rate - encourages expansion

  
• Inflation rate


  The percentage rise in an economy's price level over a period of time
• Price level / general price level

  The average of current prices across the entire spectrum of goods and services produced in an economy
• Inflation


  A sustained increase in an economy's prices overtime
• Deflation


  A general decline in prices for goods and services, typically associated with a contraction in the the economy
• Disinflation


  A fall in the inflation rate but it is still positive
• Creeping inflation


  A low, stable rate of inflation, which may actually encourage output

  
• Hyperinflation


  A very high rate of inflation, which may result in people losing confidence in the currency
• Calculating the inflation rate

  1. Annual average method

  2. Year-on-year method

  
• Consumer price index


  • A measure that shows the average change in prices of a representative basket of products purchased by households
  • Indicates the changes in costs of living
• Measurement of inflation and deflation using the consumer price index

  1. Select a base year

  2. Carry out a survey to indicate spending patterns

  3. Attach weights to different categories

  4. Multiply weightings by price changes

  
• The difficulties of measuring changes in the price level include: the base year, the survey, and the basket of goods and services

  
• Real GDP


  Nominal GDP x (price index in base year / price index in current year)

  
• Cost-push inflation


  When prices are pushed up by increases in the cost of production

  
• Demand-pull inflation


  When prices are pulled up by increases in aggregate demand that are not matched by equivalent increases in aggregate supply

  
• Wage-price spiral


  Higher wages causing prices to rise which, in turn, push up wages and so on

  
• Monetarists


  Economists who consider that inflation is caused by excessive growth in the money supply

  
• Inflation spiral


  Demand pull factors and cost push factors may interact and reinforce each other

  
• Link between cost-push and demand-pull inflation


  Some changes could increase both AD and costs of production, and once inflation occurs there is a chance of an inflation spiral

  
• Possible costs of inflation

  • Reduction in Net exports
  • Unplanned redistribution of income
  • Menu costs - costs involved in changing prices
  • Shoe leather costs - costs in moving money around in search of higher interest rates
  • Fiscal drag → increased wages = increased tax
  • Discouragement of investment
  • Inflationary noise → money illusion
  • Inflation causing inflation

  
• Possible benefits of inflation

  • Stimulates output
  • Reduces the burden of debt
  • Prevents some unemployment
• Factors affecting the consequences of inflation

  • The cause of inflation
  • The rate of inflation
  • If the rate of inflation is accelerating or stable
  • If the inflation rate is the one that has been expected
  • How the inflation rate compares with the rate of other countries