Inflation

• Define Inflation

  Sustained rise in the general price level over time. This means that the cost-of-living increases and the purchasing power of money decreases.
• Define Deflation

  where the average price level in the economy falls - negative inflation rate
• How is the inflation rate measured using the CPI

  The Consumer Prices Index (CPI)  measures household purchasing power with the Family Expenditure Survey. The survey finds out what consumers spend their income on. From this, a basket of goods is created. The goods are weighted according to how much income is spent on each item. Petrol has a higher weight than tea, for example. Each year, the basket is updated to account for changes in spending patterns. In the UK, it is a government macroeconomic objective for inflation to be at 2% + or – 1%. This is to maintain price stability.
• Limitations of CPI when measuring inflation

  • The basket of goods is only representative of the average household, so it is not accurate for households who do not own cars, for example, and therefore do not spend 14% of their income on motoring
  • Different demographics have different spending patterns
  • Housing costs account for about 16% of the index, yet this varies between people
  • CPI is slow to respond to new goods and services, even though it is updated regularly
  • It is hard to make historical comparisons, since technology twenty years ago was of a vastly different quality, and arguably a different product altogether, than now
• Strengths of CPI when measuring inflation

  • Ignores new products until they become a staple good
  • Consistently measures a set of goods that the consumer faces
  • Can aid in fiscal policy predictions
• What is RPI

  RPI stands for retail price index and is used to measure inflation and usually has a higher value than the CPI as it accounts for housing costs such as mortgages or council tax
• Demand-pull Inflation

  Inflation from the demand side of the economy
• What is demand-pull Inflation

  From the deamnd-side of the economy, when AD exceeds supply/ Whne AD is growing unsustainbly there is pressure on resources so producrs increase prices. Usually occurs when resources are fully employed

  The inflation will be more impactful if the new equilibrium output is closer to the full employment level, it will be less effective if there is spare capacity
• Main triggers for demand-pull inflation

  • Depreciation in the exchange rate - imports become more expensive while exports become cheaper so AD rises
  • Fiscal stimulus in the form of lower taxes or more government spending - more disposable income and higher AD
  • Lower interest rates - savings become less attractive and borrowing more attractive so AD increases
  • High growth in UK export markets means exports and AD rise
• What is cost-push inflation

  Inflation from the supply-side of the economy i.e when firms face rising costs - causes AS to shift left
• What can cause cost-push inflation

  Raw materials and labour becomes more expensive

  Expectations of Inflation - if a consumer expects prices to rise then may spend now which could increase inflation or demand higher wages which could also increase inflation

  Indirect taxes - increases costs of goods and this cost may be passed down onto the consumer

  Depreciation - imports become more expensive and prices rise

  Monopolies can exploit consumers with high prices
• What is the affect of inflation on consumers?

  Those on low and fixed incomes are hit hardest by inflation die to its regressive effect, becuase the cost of necessities such as food and water become expensive. The purchasing power of money falls, which affects those with high incomes the least

  If consumers are on loans, the value of the repayment will be lower because the amount owed does not increase with inflation, so the real value of debt increases