Inflation

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Inflation

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The rate of change of the average price level

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Consumer price index (CPI)

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A measurement of the general level of prices in the UK

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Deflation

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A situation in which the average level of price is falling a.k.a negative inflation

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Hyperinflation

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Occurs when a country experiences very high and are usually exhilarating interest a.k.a decrease in the value of the currency

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disinflation

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A fall in the inflation rate a.k.a general price level is increasing at a slower rate

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Nominal value

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The value of an economic variable based on current prices taking no account of changing prices through time.

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Real value

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The value of an economic variable Taking account of changing price through time

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Demand pull inflation

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Increase in the price level increase in aggregate demand

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Demand pull inflation

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Increase in the price level cause by increase in aggregate demand

A depreciation in the exchange rate, imports becomes more expensive, whilst exports become cheaper. This causes AD to rise.

 Fiscal stimulus in the form of lower taxes or more governmentspending. This means consumers have more disposable income, soconsumer spending increases.

 Lower interest rates makes saving less attractive and borrowing moreattractive, so consumer spending increases.

 High growth in UK export markets means UK exports increase and ADincreases.

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Cost push inflation

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Arise when the price level is pushed up by increases in the cost of production

Raw materials become more expensive, such as when oil prices rise.

 Expectations of inflation- if consumers expect prices to rise, they mayask for higher wages to make up for this, and this could trigger more inflation.

 Indirect taxes could increase the cost of goods such as cigarettes orfuel, if producers choose to pass the costs onto the consumer.

 Depreciation in the exchange rate, which causes imports to becomemore expensive, which pushes up the price of raw materials.

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consequences of inflation

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Firms have to keep amending their price list raising the cost of undertaking transactions

High inflation gives rise to a number of costs (menu cost of inflation)

People try to keep the money in interest bearing accounts

Shoe leather cost of inflation

Is to be a bit of change of price cannot be confidently predicted by firms they may be reluctant to investment

Inflation may inhibit the ability of prices to act as a reliable signal in the process, leading to a wastage of resources and lost business opportunities

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Converting nominal measurements to real

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100X nominal value/Real GDP= Price index

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Consequences of deflation

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o This could lead to a sharp decline in consumer spending, since consumers wait for prices to keep falling before spending.

o The economy might crash and the unemployment rate might increase. This can add more deflationary pressure to the price level. This is why deflation can quickly spiral out of control.

o Nominal wages are often ‘sticky’, which means workers resist pay cuts. This means real wages rise when there is deflation, which could cause unemployment.

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Calculating CPI, RPI, nominal value and real value

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cost to consumers

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 the cost of necessities such as food and water becomes expensive. The purchasing power of money falls, which affects those with high incomes the least.

 If consumers have loans, the value of the repayment will be lower, because the amount owed does not increase with inflation, so the real value of debt decreases.

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Cost to the government

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 The government will have to increase the value of the state pensionand welfare payments, because the cost of living is increasing.