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Economics 2.1.2
Economics- Edexcel 2.1.2
| Question | Answer |
|---|---|
| inflation | sustained increase in the cost of living or the general price level leading to a fall in the real purchasing power of money |
| GPL | general price level |
| What measures the rate of inflation? | annual percentage change in consumer prices |
| UK government target of inflation | 2% using the consumer prices index |
| CPI | consumer prices index |
| MPC | Bank of England’s Monetary Policy Committee |
| How does the UK meet it’s inflation target? | MPC sets monetary policy to help sustain growth and employment |
| disinflation | fall in the rate of inflation but not sufficient ot bring about deflation(consumer prices rise but at slower rates) |
| Consumer price index measures | main measure of inflation used in the UK and European Union |
| Consumer price index | family expenditure survey chooses a representative basket of over 700 goods and services with weights attached to each item that are multiplied by price changes, these are totalled to calculate the inflation rate |
| Base year | the year with which the values from other years are compared |
| Index value of the base year | set as 100 |
| Consumer price index equation | (current price index*weighting)/sum of weights |
| CPIH | CPI + owner-occupied housing costs |
| OOH | owner-occupied housing |
| Why isn’t CPIH used? | OOH lacks statistical validity |
| Owner-occupied housing costs | costs of housing services associated with owning, maintaining and living in a house |
| Creeping inflation | small rises in the general price level over a long period with low positive rate of inflation |
| deflation | decline in the GPL signified by an annual inflation rate of below 0%(negative) |
| GPL | general price level |
| hyper-inflation | period of high rates of inflation usually leading to a loss of confidence in a currency |
| Inflation expectations | rate of increase of consumer prices expected by consumers, expectations can influence spending and saving decisions and wage bargaining |
| Inflation rate | annual rate of change of the average price of goods and services |
| Price stability | when there is a low positive inflation rate of between 1-3% and price changes that do occur have little impact on day-to-day decisions of people and businesses |
| Purchasing power | bing power of a unit of currency, inversely related to the rate of inflation |
| stagflation | combination of slow growth and rising inflation |
| Transitory inflation | temporary or short-lived increase in the rate at which consumer prices are rising in an economy, but isn’t thought to be long-lasting and inflation rate should drop back again |
| Unit labour costs | reflect total labour costs incurred in the production of a unit of economic output |
| Total labour costs include | social security & employers’ pension contributions and costs of self-employed labour |
| Main cause of inflation | money and credit boom/ higher wage costs/ increased energy bills / falling exchange rate |
| Domestic causes of inflation | inflationary pressures within the domestic economy, e.g. rising wage costs & increases in the prices and costs of component parts and raw materials including energy |
| External causes of inflation | inflationary pressures from outside of a particular country, e.g. increase in global price of oil, gas and other commodity(rubber, copper & iron ore) |
| Why is inflation expectations important? | difficult to remove inflation once established/agents raise their inflation expectations so if people expect higher prices then there can be higher wage claims and rising labour costs |
| cost -push inflation | cost of production increases(independent of AD changes), inward shift of SRAS, output of goods and services and real output fall(rise in costs leads to fall in business profits & planned capital investment spending) |
| SRAS | short-run aggregate supply |
| What can cost-push inflation bring about? | stagflation |
| Most notable period of stagflation | 1970s as oil prices rose a lot, increasing inflation to 30% |
| Demand-pull inflation | when total demand for goods and services(AD) exceeds total supply |
| Explanation behind demand-pull inflation | as economy approaches full employment:labour and raw material shortages + supply turns inelastic/ excess demand / producers raise prices(bigger profit margins) |
| When does demand-pull inflation usually happen? | when there is full employment of resources & AS is inelastic |
| Positive output gap | actual GDP>potential GDP |
| ‘Too much money chasing too few goods’ | economy’s money supply is increased more quickly than the economy’s growth rate so there is an inflation pressure on consumer prices |
| Fisher formula | MV=PT |
| M in Fisher formula | money supply |
| V in Fisher formula | velocity of money(how many times it changed hands), a constant value |
| P in Fisher formula | price level |
| T in Fisher formula | volume of output, a constant value |
| Potential winners from rising inflation | workers with strong wage bargaining power/debtors/producers/wealthy groups |
| Why do debtors benefit from rising inflation? | if real interest rates on loans are negative |
| Why do workers with strong wage bargaining power benefit from rising inflation? | protect real incomes by bidding for higher wages |
| Why do producers benefit from rising inflation? | if prices rise faster than costs leading to higher profit margins |
| Why do wealthy groups benefit from rising inflation? | if sustained period of asset price inflation |
| Asset price inflation | when the prices of financial assets rise above their underlying or intrinsic value |
| Potential losers from rising inflation | retired people on fixed incomes/lenders/ savers/ workers in jobs with low bargaining power/exporting firms/jobs that rely on inward foreign investment |
| Why do people on fixed incomes lose with rising inflation? | inflation cuts the real value of their pensions and other savings |
| Why do lenders lose with rising inflation? | if real inflation rates charged on loans are negative |
| Why do savers lose with rising inflation? | if real returns on commercial bank deposits are negative |
| Why do workers in jobs with low bargaining power lose with rising inflation? | cannot protect their real incomes by bidding for higher wages |
| Why do exporting firms lose with rising inflation? | become less competitive, losing sales and profits |
| Risks of high and volatile inflation | inequality/ falling real incomes/negative real interest rates/cost of borrowing/ risks of wage inflation/business competitiveness/business uncertainty |
| effects of high inflation depend on | if temporary or not/inflation in competitor countries/extent central bank tolerates inflation without interest rates/wage bargaining power of workers/if nominal interest rate on savings keep up/if uncertainty decreases domestic & foreign inward investment |
| policies that reduce inflation by slowing the growth of AD or expands AS | fiscal policy, monetary policy, supply side policies, direct controls imposed by government or regulators on wages and prices |
| how does the fiscal policy reduce inflation? | tighten fiscal policy including less spending on state-provided services, reduced welfare payments or raising direct taxes to cut household disposable income and consumer spending |
| how does the monetary policy reduce inflation? | tighten monetary policy, squeezing growth of AD / higher interest rates, exchange rate to appreciate bringing cheaper imported goods, reduction in CSI |
| how does the supply side policies reduce inflation? | increases labour productivity, competition and innovation within markets |
| how does the direct controls imposed by government or regulators on wage and prices reduce inflation? | public sector wage controls(1% pay cap increase for NHS workers), capping or other regulation of prices of utilities, capping interest rates charged on unsecured loans by payday lenders |
| main causes of price deflation: demand-side causes of deflation(malign deflation) | fall in AD causes persistent recession, slows economic growth, firms cut prices to offload stock & improve cash flow, large negative output gap with high level of spare capacity |
| other name for demand-side deflation | malign deflation |
| malign deflation | A persistent fall in the general price level, output and employment brought about by a steep fall in and then persistently low levels of aggregate demand |
| main causes of price deflation: supply-side causes of deflation(benign deflation) | improves productivity of labour and capital/higher efficiency=lower unit costs of supply/tech advances/falling wage rates & prices for other inputs/high exchange rate=import prices fall |
| other name for supply-side deflation | benign deflation |
| benign deflation | a fall in the general price level brought about by an outward shift of the short run aggregate supply curve |
| Economic effects of persistent price deflation | holding back on spending/debts increase/lower profit margins/confidence and saving/income distribution/exporters are more competitive |
| Why hold back on spending during deflation? | postpone demand if expect prices to fall further in future, lowering AD |
| Why do debts increase during deflation? | real value of debt rises and higher real debts are a big drag on consumer confidence and spending, so the real cost of borrowing increases(real interest rates rise if nominal interest rates aren’t i line with prices) |
| Why are profit margins lower during deflation? | lower prices reduce revenues and profits for businesses leading to higher unemployment as firms reduce costs by shedding labour |
| How is income redistributed during deflation? | income is redistributed from debtors to creditors but debtors may default on loans |
| Default occurs | when a borrower stops making the required payments on a debt |
| How do exporters become more competitive during deflation? | slowly and at a cost- there’s a significant time lag between falling prices and an expansion in overseas demand and there are higher rates of unemployment |
| how can we tighten monetary policy | via higher interest rates or reversal of quantitative easing or tougher controls on commercial bank lending |
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jessharris
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