2.1.2 Inflation
Inflation: the change in the general price level of an economy
Deflation: a negative change in the general price level of an economy
Dis-inflation: a positive change in the price level of an economy, but a smaller change since the previous year
CPI (Consumer Price Index) - the main measurement of inflation in the UK, although doesn't include housing prices
RPI (Retail Price Index) - includes housing prices and taxation.
Causes of Inflation:
Demand Pull-
Caused by a rise in AD (Aggregate Demand) either through an increase in consumption, investment, Government spending or an increase in the terms of trade. This is the preferred form of inflation, as it comes with economic growth and higher employment.
Cost-Push-
Caused by a rise in the price of the factors of production. This leads to firms' costs increasing, so they increase prices, pushing the burden onto consumers. As prices rise, firms face less demand for their products, reducing revenue. They may fire workers in order to reduce costs, meaning less consumers have disposable income to spend in the economy, causing cyclical unemployment. Prices rise while output and employment decrease.
Growth of the Money Supply-
This occurs through Quantitative Easing, via Government bonds through the Bank of England. Money supply increases when interest rates are low. This causes inflation as AD increases, meaning it is demand-pull inflation.
Effects of Inflation on:
Consumers- Reduces PPP (Purchasing Power Parity), as inflation increases, their income becomes more worthless.
Firms- They experience higher costs (e.g. menu costs), wage pressures (workers demanding wage rises), their goods/services become less internationally competitive, there may be less investment as confidence in the economy is low, however due to economic growth, they may see a rise in demand.
The Government- They gain more tax revenue as people are pushed into higher tax brackets, however their terms of trade may decrease as firms are less international competitive.
Workers- If inflation is demand-pull, workers could benefit as wages are likely to rise as firms are trying to attract workers, however if inflation is cost-push, cyclical unemployment could be caused as a result.
RPI (Retail Price Index) - includes housing prices and taxation.
Causes of Inflation:
Demand Pull-
Caused by a rise in AD (Aggregate Demand) either through an increase in consumption, investment, Government spending or an increase in the terms of trade. This is the preferred form of inflation, as it comes with economic growth and higher employment.
Cost-Push-
Caused by a rise in the price of the factors of production. This leads to firms' costs increasing, so they increase prices, pushing the burden onto consumers. As prices rise, firms face less demand for their products, reducing revenue. They may fire workers in order to reduce costs, meaning less consumers have disposable income to spend in the economy, causing cyclical unemployment. Prices rise while output and employment decrease.
Growth of the Money Supply-
This occurs through Quantitative Easing, via Government bonds through the Bank of England. Money supply increases when interest rates are low. This causes inflation as AD increases, meaning it is demand-pull inflation.
Effects of Inflation on:
Consumers- Reduces PPP (Purchasing Power Parity), as inflation increases, their income becomes more worthless.
Firms- They experience higher costs (e.g. menu costs), wage pressures (workers demanding wage rises), their goods/services become less internationally competitive, there may be less investment as confidence in the economy is low, however due to economic growth, they may see a rise in demand.
The Government- They gain more tax revenue as people are pushed into higher tax brackets, however their terms of trade may decrease as firms are less international competitive.
Workers- If inflation is demand-pull, workers could benefit as wages are likely to rise as firms are trying to attract workers, however if inflation is cost-push, cyclical unemployment could be caused as a result.
