Define inflation
A general and sustained increase in prices, measured by CPI
Define deflation
A fall in the general level of prices (negative inflation)
Define disinflation
A fall in the general rate of inflation (prices rise more slowly)
CPI
- Survey on expenditure used to create basket of goods
- Price survey taken by civil servants who collect data once a month on 650 most commonly used goods/services
Limitations of CPI
- Does not include housing costs
- Measures cost of living for average household (does not include top/bottom 4%
- Sampling problems = only 57% respond
- Not representative of people with atypical spending habits
Define retail price index
Index used to measure inflation that includes housing costs such as mortgage interest repayments
- More inclusive than CPI but not suitable for international comparisons (unique to UK)
Define demand-pull inflation
An increase in general level of prices caused by increased consumption, investment, government spending or net exports (AD right)
Define cost-push inflation
An increase in the general level of prices caused by increased production costs such as a rise in wages or a fall in the exchange rate (AS left)
Effects of inflation on consumers
- Real values of savings down as price up
- PPP of people on fixed incomes decrease as price increases
- People with high levels of debt benefit = real value of debt falls
Effects of inflation on firms
- Lots of international competitiveness = exports more expensive and imports cheaper = BOP worsen
- More uncertainty
- Less investment from abroad = value of money has fallen
- Higher prices means firms may be able to make more profits (especially in short term)
Effects of inflation on the government
- Redistribution of income = people on fixed incomes will find fall in income
- Fall in real interest rate so cost of borrowing falls
Effect of inflation on workers
- Some workers may want higher wages but firms not confident to may more
- Trade-off between wage inflation and unemployment (Short run Phillips curve) = high wage rate inflation means easier for people to find work because firms are raising wages