2.1.2: Inflation

• Inflation: Sustained increase in general price level
• Deflation: Sustained decrease in general price level
• Disinflation: Where rate of inflation is decreasing, but is still positive
• The government's inflation target is 2 %
• Inflation is calculated using CPI, tracking changes in the price of a basket of goods and services purchased by an average household
• CPIH: CPI which also includes costs associated with owning and maintaining a home
• RPI: Includes mortgage interest payments and council tax. Doesn't include the top 4 % income earners and low income pensioners
• Limitation of CPI: It is only calculated for families
• Limitation of CPI: It does not consider changes in quality of goods and services
• Limitation of CPI: Needs regular updating to reflect changes in spending
• Limitation of CPI: International comparisons may be less accurate if other countries calculate inflation in different ways
• Shoe Leather costs: Additional costs incurred when prices change rapidly such as more transport
• Menu costs: Costs of redoing menus, parking charges and more
• Cost of inflation: Fall in real incomes if wages do not rise with prices
• Cost of inflation: Reduced spending by consumers and firms due to uncertainty
• Cost of inflation: Weaker current account, as exports become more expensive and imports become cheaper
• Benefit of low Inflation: Helps labour markets to work efficiently without needing to change wages often
• Demand Pull inflation: Inflation caused by excess aggregate demand in the economy
• Cost push inflation: Inflation caused by increases in costs of production in the economy
• Causes of Demand Pull Inflation:

  Low interest rates

  Low income tax

  Rapid income growth

  High confidence

  Easy credit

  Weak currency
• Causes of Cost Push inflation

  Increase in wages

  Increasing raw material costs

  Increasing commodity prices

  Increase in indirect tax

  Weak currency
• Inflation may also be caused by too much money in the economy
• Cost of deflation: Lower AD causes excess supply
• Cost of deflation: Lower prices for goods and services cuts profit for firms as consumers delay spending
• Cost of deflation: Increase in real value of debt
• Benefit of Deflation: Lower prices for consumers
• Benefit of Deflation: Increase in real income
• Benefit of Deflation: Improved international competitiveness
• Benefit of Deflation: Falling asset prices make housing more affordable