Inflation - AS Economics

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Inflation is a sustained increase in the general price level.

Disinflation is a fall in the rate of increase in the general price level.

Deflation is a sustained decrease in the general price level.

Cost-push inflation occurs when costs of production increase across the economy, resulting in a decrease in short run aggregate supply, which pushes up the price level.  This can occur due to changes in unit labour costs (such as wages and productivity), prices of factors of production (influenced by exchange rates) and government taxes.  Workers will negotiate for higher wages to retain their real disposable income, further increasing production costs and leading to a wage-price spiral.

Demand pull inflation occurs when either consumption, government spending, investment or net exports increase. Supply struggles to meet demand, and older, less efficient factors of production are employed.  Workers are paid more overtime but can only produce so much more, leading to a rise in the price level.

Monetary inflation results from an increase in the money supply.  This is shown through the equation MV = PT.  If we assume V (velocity of circulation) and T (total output) remain constant, we see that an increase in M (money supply) leads to an increase in P (price level).

Alternatively, this can be shown on the loan market.  An increase in supply of money lowers the cost of borrowing (interest rates), which will increase consumption and investment in the economy.

Inflation makes borrowing more attractive to households and helps those owing money, as the real value of their debts decrease.  However the value of savings will erode, and those on fixed incomes will see a fall in real disposable income.  Households face shoe-leather costs as they move their money between financial institutions and invest in real assets that keep their value (such as gold).

Inflation also makes borrowing more attractive to firms, as real interest rates may become negative, effectively meaning that they are being paid to borrow money.  This can increase investment.  Firms may also be able to save money for investment without cutting nominal wages to workers, which would be unpopular.  Workers will be more likely to accept flat wages when inflation is at 3% than a 3% wage decrease when there is no inflation.  In addition, consumers will be more willing to accept price rises even if they are greater than the rate of inflation, resulting in higher profits.  Inflation may signal strong demand throughout the economy, boosting business confidence.  Importing firms find the products they sell are more competitive in the domestic market

However there…

Comments

MarcusFisher

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Inflation makes borrowing more attractive to households and helps those owing money, as the real value of their debts decrease. - could you explain this please?

Cora Crotty-Joyce

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Amazing xxxxxxxxxxxxxxxxxxxxxxx <3

davidsalter

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This set of revision notes goes through the main points on inflation including its effects, causes and calculation. The test yourself allows some interaction and may point to further revision needs.

Adam "Inbred" Smith

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you are a pathetic waste of life and I hope you step on Lego

dannyk131

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why would you say that

butterfly

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Household may have more credit because their house price increases. So they r more likely to borrow for travel or whatever knowing that worst comes to worst they can sell their house to repay the loan. Borrowers have to pay less back in value because now the same amount of money borrowed before has fallen in value. But I don't understand how the real value of debts increases.

LuisHendren

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Understanding inflation is crucial for any economics student. Inflation refers to a sustained increase in the general price level, while disinflation indicates a decrease in the rate of that increase. Deflation, on the other hand, is a sustained decrease in the general price level. There are various causes of inflation, including cost-push inflation, where rising production costs lead to higher prices, and demand-pull inflation, which occurs when increased demand outstrips supply. I needed to deepen their understanding of these concepts, I read https://edureviewer.com/services/paperdon-review/ a review of helpful service that can aid your studies. Monetary inflation, driven by an increase in the money supply, can also be understood through the equation MV = PT. It's essential to grasp these different types of inflation and their implications for the economy. This knowledge not only helps in exams but also provides a solid foundation for future economic studies.

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