LOW INFLATION

DEFINITION  A SUSTAINED GENERAL RISE IN PRICES

DISTINGUISH  CREEPING INFALTION  HYPER-INFLATION

HOW IS IT MEASURED  Surveyors are sent out to record the prices of a basket of goods in a variety of different retail units. Price changes are then recorded and calculated. Changes in prices are weighted. This means that changes in price of goods which form a large proportion of spending (oil) plays a more significant role than goods which are not so significant (pineapple).

 The weighted price changes are then recorded against a base value of 100.  A change in the price level is known as  Inflation or Deflation.  The measurement tool is known as the Consumer Price Index.

Accuracy of Price Indices  It is important to realise that a price index is a weighted average.  What does that mean?

Why is it important to calculate the rate of inflation?  Trade Unions need to know.  Government needs to know and base changes in spending and taxes on it.

CPI and RPI  The RPI (Retail Price Index) covers more than the CPI –  RPI Also Includes:  Mortgage interest payments  (MIPs)  Council tax

CPI Does not include  Mortgage payments  Council taxes

Weaknesses of the CPI  There can be statistical errors.  Cannot study the black market.  Ignores house interest repayments.  Ignores the quality of the goods.

Causes of Inflation  Insert funny picture?

Unbelievable

Demand Pull Inflation  Caused by excessive demand in the economy.  Graph

Causes of Demand Pull Inflation  Rise in consumer spending caused by low interest rates.  Firms may raise investment spending.  Government tax cuts

Cost Push Inflation  Changes occur in the supply side of the economy.

Causes  Wages- Account for 70% of the national income.  A rise in wages could be a significant cause of rise in costs of production.

Causes  Import prices may rise.  The U.K. Imports 50% of its food.  What else would they have to import?

 Governments can raise indirect tax rates or reduce subsidies, causing an increase in the cost of production.

Remember  Firms will try to pass increased prices on to consumers.  To what extent is this possible?

DEFLATION AND WHAT IT MEANS TO YOU.  Defined as the fall in price level.

Supply Side Deflation  Not that bad for the economy.  Decrease in overall costs of production.  Lower import prices  Lower minimum wage  Appreciation of nation`s currency.  Lower taxes

Fall in AD Deflation  Not good for the economy.  This is caused by a fall in aggregate demand.  What are the components of aggregate demand?

Costs of Deflation  Rising unemployment  Fall in investments  Falling consumption and increased savings.

THE COSTS OF INFLATION

Loss of Purchasing Power  If prices rise and household incomes do not, then households become poorer in real terms.

Lower Real Interest Rates for Savers  A Household invests in a fixed interest rate investment of 4%.  Inflation goes up by 7%  How did that work out for the household?

Higher Nominal Interest Rates for Borrowers  In times of inflation banks charge a higher interest rates to borrowers.

Redistribution of Income  Anybody on a fixed income will suffer in times of inflation.  This is why some fixed incomes are tied to rates of inflation.

 Taxes and government spending may not change with rates of inflation.  How could this be bad for a government?

Reduction In Ability to Sell Goods Abroad  Why?