5. Inflation
• Defining inflation
Inflation is a general rise in average prices.
• Two measures of inflation:
– Consumer Price Index (CPI)
– Retail Price Index (RPI)
• Types of Inflation:
– Demand pull inflation
– Cost push inflation
• In economics we show these using AD & AS
diagram.
6. Inflation
• Inflation in historical perspective
– low inflation in 1950s and 60s
– high inflation in 1970s and 80s
– low inflation since mid 1990s
• most developed countries gear monetary policy
to achieving a low target rate of inflation, 2%
• Inflation has been kept under control in the UK
and other industrialised economies.
7. -5
0
5
10
15
20
25
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
UK USA
Eurozone Japan
Annual
%
increase
in
GDP
deflator
Inflation rates in selected industrialised economies
Notes: 2014 and 2015 based on forecasts; Eurozone = the 17 countries using the euro in 2013
Source: Based on data in World Economic Outlook Database (IMF) and AMECO Database (European Commission, DGECFIN)
9. Factor
Payments:
Wages +
Rents
Interests
Profits__
Income
Investment (I)
Government (G)
Export (X)
BANKS, etc
saving (S)
GOV.
taxes (T)
ABROAD
Import (M)
The circular flow of income
WITHDRAWALS
INJECTIONS
Consumption
of domestically
produced
goods &
services
(Cd)
AS = Output
Production: Value adding activities
AD = C + I + G + (X – M)
10. O
Price
level
National output
AD
Aggregate demand
Aggregate means Total
Why the AD curve slopes downwards
• lower price level leads to fewer imports
• lower price level tends to cause interest
rates to fall
• lower price level increases value of
people’s savings
12. O
Price
level
National output = GDP
AS
AD1
P1
Q1
AD2
P2
Q2
A rise in aggregate demand
causes a rise in the price
level (and also a rise in real
GDP)
Demand-pull inflation
13. Q As the price level in the economy rises, which
of the following occurs?
(i) The quantity of ‘real money’ decreases;
(ii) Real aggregate demand decreases;
(iii)Total spending in money terms decreases.
A. (i) only
B. (ii) only real money = notes & coin
C. (i) and (ii)
D. (i) and (iii)
E. (i), (ii) and (iii)
14. O
Price
level
National output = GDP
AS1
AD
P1
Q1
AS2
P2
Q2
A rise in costs causes
a rise in the price level
(but also a fall in real
GDP)
Cost-push inflation
15. Q Which one of the following would be the
cause of cost-push inflation?
A. A cut in the rate of income tax.
B. A cut in the rate of VAT
C. A cut in interest rates
D. A rise in the exchange rate
E. A rise in the price of oil
17. Q Suppose that the CPI in a country
increases from 150 to 153 over a period of a
year. What is the rate of inflation?
A. 3%
B. 2% Reason: [(153 – 150)/150] * 100
C. 1.02%
D. 0.03%
E. 0.02%
18. Q In a period of rapid inflation which of the
following would be the least desirable store
of wealth?
A. Vintage wine.
B. Property
C. Money
D. Land
E. Stocks and shares]
19. Policies to tackle inflation
– demand-side policies
– supply-side policies
See text for the application of demand
side and supply side policies.
20. 0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
Unemployment
(%
of
workforce)
.
UK USA
Eurozone Japan
Standardised unemployment rates
in selected industrialised economies
Notes: 2016– 20 based on forecasts; Eurozone = the 19 countries using the euro in 2016
Source: Based on data in World Economic Outlook Database (IMF)
21. Unemployment
Types of Unemployment
• Equilibrium unemployment
− Frictional: Duration of search
− Structural: Change in technology, demand,
− Seasonal : Regional
• Disequilibrium unemployment
− Real-wage: Wages higher than equilibrium
− Demand-deficient (cyclical): Low demand
25. Q Frictional unemployment is the result of:
A. a shift in the pattern of consumer demand.
B. workers and employers being ill-informed about
the labour market.
C. the introduction of new technology.
D. the economy entering the recessionary phase
of the business cycle.
E. employers responding to the time of year and
cutting back on their level of production.
26. Q Which of the following defines real-wage
unemployment?
A. Real wages being set above the equilibrium level
by trade unions, or minimum wage legislation.
B. Inflation causing an erosion of real wages and
hence a rise in unemployment.
C. Increased aggregate demand in the economy
driving up equilibrium real wages.
D. Increased aggregate demand in the economy
causing money wages to rise faster than real
wages.
E. Real wages falling below the equilibrium level as
a result of deficiency of demand.
27. Unemployment
• Costs of unemployment
– financial cost to individual
– non-monetary cost to individual
– cost to family and friends
– economic cost
• taxes and benefits
• loss of output
• reduced consumer spending
• lower profits
– long-term unemployment
• Is some unemployment a good thing?
