Inflation and Causes of Inflation? Q.
1) What is inflation?
2) What is deflation?
3) What is demand-pull Inflation?
4) What is cost-push inflation?
Inflation and Causes of Inflation? A.
1) Inflation is a rise in the general prices of an economy, sustained over time.
2) Deflation is a fall in the general level of prices in an economy, sustained over time.
3) 'Too much money chasing too few goods'. Inflation can caused by an increase in demand in the economy.
4) Inflation can occur when supply in the economy decrease because firms costs rise, so their prices must rise and average prices rise.
Why is inflation a problem? Q.
1) Why is inflation bad for savers?
2) Why is inflation good for borrowers?
3) How does inflation effect inflation rates?
4) Why is inflation bad for investment?
5) What happens to menu costs when inflation occurs?
6) What happens to the Wage price spiral?
Why is inflation a problem? A.
1) Inflation is bad for savers because if the worth or value of money falls with inflation. The money that you saved cannot buy as much as it did.
2) Inflation is good for borrowers the value of their debt goes down with inflation. The money they initially borrowed is woth less in the future.
3) The interest rate is the return on savings and cost of borrowing. If inflation goes up, inflation rates go up, interest rates go up and the cost of borrowing rises.
4) If inflation goes up then interest goes up, the cost of borrowing goes up, so firms take out less loans and investment falls. Firms cannot plan and cannot invest.
5) As inflation occurs prices rise, so firms have to change their menus, catalogues, websites and shop signs. This costs time and money.
6) Aspricesrise, consumers cannot afford as much as before, so they demand higher wages, so firms' costs go up, and their prices rise etc.
How to measure inflation. Q.
1) What is Consumer Price Index (CPI)?
2) What is Retail Price Index (RPI)?
How to measure inflation. A.
1) CPI is collected from a survey where over 100,000 prices are gathered each month for an 'average basket' of goods (650 goods). What is in the 'average basket' changes over time as buying habits change. It is based on the average basket of goods brought by all households.
2) RPI is a more appropiate way to measure wage increase. It is more inclusive than CPI, but is not as reliable for international comparisons. Also, RPI includes the cost of mortgage interest payments.
What is wrong with using CPI?
- CPI measures the cost of living only for the average household. The top and bottom 4% income brackets are not included, and neither are pensioners.
- There are sampling problems: only 57% of households respond to the survey, and when they do respond they might not give accurate information.
- The items in the 'basket' are changed only once a year, but tastes and fashions change more quickly. Also, it ignores deals like 'buy one, get one free'.
- For people with atypical spending patterns, such as vegetarians or non-drivers, the CPI measure will be unrepresentative.