![Aquinas College Economics Department
Consequences of Inflation
Consequence Explanation
Global Competitiveness Makes UK Goods more expensive on foreign
markets [BoP issues]
Investment As inflation creates uncertainty investment
levels fall
‘Menu Costs’ Admin costs to business when changing prices
‘Shoe-Leather Costs’ Cost to consumers who shop around
Distribution of Income Savers lose out with a real interest rate
Employer-Employee Relationship Workers demand higher pay, resulting in a
wage-spiral
Fiscal Drag When tax exempt amounts are not increased in
line with inflation meaning tax payers may be
dragged into the next tax band
Hyperinflation Currency is effectively worthless and a barter
economy appears](https://image.slidesharecdn.com/inflationanddeflation-130610064425-phpapp02/75/Inflation-and-Deflation-14-2048.jpg)
Uploaded byAquinas College Economics Department
Inflation and Deflation
The document provides an overview of inflation and deflation, including their definitions, calculation methods, causes, and consequences. It explains the Consumer Price Index (CPI) as a measure of inflation in the UK and discusses limitations of CPI. Additionally, it distinguishes between benign and malevolent deflation and highlights the economic implications of both inflationary and deflationary trends.
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Inflation and Deflation
- 1. Aquinas College EconomicsDepartment Inflation & Deflation How its calculated, the causes, consequences, and the scary situation that is deflation ECON4
- 2. Aquinas College EconomicsDepartment Definitions Inflation: a sustained increase in the general price level Deflation: a fall in the general price level CPI – Consumer Price Index
- 3. Aquinas College EconomicsDepartment Inflation A sustained increase in the price level Normally measured in the UK through the Consumer Price Index. UK government target for inflation is 2% This target has an limit of +/- 1% as it can be difficult to bring inflation under control
- 4. Aquinas College EconomicsDepartment Consumer Price Index Measure of UK Inflation Measures the prices of a basket of goods Goods are weighted so it can reflect changes in spending Information from the Family Expenditure Survey gives the information about spending paterns
- 5. Aquinas College EconomicsDepartment The Basket of Goods Source: The Guardian The basket is changed depending on what people are buying Film Camera’s have been removed from the basket but iPad’s and other tablet computers have been added
- 6. Aquinas College EconomicsDepartment Weighting Using data from the FES government assigns weights to each product in the basket of goods Spending is broken down into 14 categories If Housing costs make up 30% of total spending then it is given a weighting of 30% in the basket of goods This weighting is then multiplied by the price index for that year
- 7. Aquinas College EconomicsDepartment Index Numbers When comparing figures over years, index numbers are used You establish a base year which becomes 100.0 then other years are worked out accordingly
- 8. Aquinas College EconomicsDepartment Index Example Year Index 2007 100.0 2008 101.3 2009 130.0 2010 98 2007 is being used as the base year In 2008 we can see that prices have increased by 1.3% from 2007 In 2009 prices had increased by 30% on 2007 Be Warned!!!! Caluclating the change between 2008/09 can be more difficult You must use the percentage change calculation: (130.0-101.3) / 101.3 x 100 = 28.3%
- 9. Aquinas College EconomicsDepartment Limitations of CPI 1. It is an average so is not entirely representative 2. House prices are not included 3. CPI doesn’t include quality of the goods so may over-estimate the rate of inflation experienced
- 10. Aquinas College EconomicsDepartment Causes of Inflation Inflation can come from within an economy or it can come from outside the national economy At A2 you need to know the three main ways in which inflation is caused
- 11. Aquinas College EconomicsDepartment Demand Pull Inflation Caused by a rise in demand when an economy has little capacity AD will increase leading to higher prices PriceLevel GDP LRAS AD AD1 P P1 Y Y1
- 12. Aquinas College EconomicsDepartment Cost Push Inflation Caused by increasing costs of production faced by business 1. Rise in raw material cost 2. Rising wages 3. Higher rates of VAT 4. Wage-Price Spirals PriceLevel GDP AS AD P P1 YY1 AS1
- 13. Aquinas College EconomicsDepartment Increase in Money Supply Quantity Theory of Money says that an increase in the money supply will cause price levels to rise Key argument of Monetarists See separate PowerPoint on QTM
- 14. Aquinas College EconomicsDepartment Consequences of Inflation Consequence Explanation Global Competitiveness Makes UK Goods more expensive on foreign markets [BoP issues] Investment As inflation creates uncertainty investment levels fall ‘Menu Costs’ Admin costs to business when changing prices ‘Shoe-Leather Costs’ Cost to consumers who shop around Distribution of Income Savers lose out with a real interest rate Employer-Employee Relationship Workers demand higher pay, resulting in a wage-spiral Fiscal Drag When tax exempt amounts are not increased in line with inflation meaning tax payers may be dragged into the next tax band Hyperinflation Currency is effectively worthless and a barter economy appears
- 15. Aquinas College EconomicsDepartment Deflation Benign deflation: fallings prices resulting from technological advances across the economy e.g. Computer Prices Malevolent Deflation: falling prices resulting from a significant downturn in economic activity - Real economic problem Deflation: a fall in the general price level
- 16. Aquinas College EconomicsDepartment Deflation If malevolent deflation exists then a downwards multiplier effect can take place Tips the economic cycle into recession
- 17. Aquinas College EconomicsDepartment AS Level Revision Site (ECON1, ECON2) • http://www.aquinaseconomicsas.co.uk A2 Level Revision Site (ECON3, ECON4) • http://www.aquinaseconomicsa2.co.uk Aquinas Economics on Twitter • http://www.twitter.com/aquinaseconomic Useful Links