Inflation = “a sustained increase in the general price level leading to a decrease in the purchasing power of money” PRICE Part Two!

Cost-Push Inflation Firms respond to higher costs by increasing prices (AS shifts inward) Causes: ↑imported raw material costs ↑ labour costs ↑ indirect or direct taxes paid by firms PL AS1 AS AD GDP

Demand-Pull Inflation AD grows faster than AS therefore prices are bid up by demand exceeding supply Causes: ↑ exports not matched by ↑ imports ↑ gov’t spending not matched by ↑ taxes ↓ interest rates → ↑ C ↑ wealth effect from ↑ house prices or stock market boom PL AS AD1 AD GDP

Impact of inflation on consumers… Positive Negative Outstanding loans are worth less in relative terms – they are easier to pay back with ‘today’s’ money Savers see the real value of their savings eroded Constantly changing prices makes big purchases hard to plan for an execute – confidence is low Impact of inflation on workers… Positive Negative Seeing the figure on your payslip rise feels like progress Workers may be made redundant as some firms struggle to pay higher wages Some workers without good bargaining power may not see wages rise in line with prices – so worse off in real terms

Impact of inflation on firms… Positive Negative Outstanding loans are worth less in relative terms – they are easier to pay back with ‘today’s’ money Menu costs – constantly changing the price of goods sold takes time and costs money Consumer are more likely to ‘shop around’ as they get nervous about price rises (shoe leather costs) If prices in the UK are rising faster than those abroad, UK firms will be less competitive and exports will fall. Consumers get nervous about the future cost of living so may reduce consumption Workers may become agitated about wage rises so may strike or take other industrial action Firms may reduce investment with the uncertainty

Impact of inflation on gov’t… Overall economic impact… Positive Negative Outstanding loans are worth less in relative terms – they are easier to pay back with ‘today’s’ money If the economy slows down, gov’t will have to pay out more in benefits and will receive less in tax revenue The real value of excise duties will decrease unless they rise in line with inflation Overall economic impact… High inflation is associated with economic uncertainty and decline Decreased investment, consumption and exports from uncertainty and lack of confidence Unrest can occur – politically or in workplaces – as workers worry that their wages may not keep up with the cost of living A spiral of rising prices / wages / prices / wages can get out of control

Coming back to REAL (sometimes called Constant Price GDP) vs CURRENT PRICE GDP Goal –how much more has the economy produced in terms of value of Goods and Services WITHOUT INCLUDING THE EFFECT OF INFLATION Lets assume we have only MARS BARS in the Economy In 1971 we produced 100 Mars Bars at 3p each In 2013 we produced 1000 Mars Bars at 75p each What is the value of GDP at current prices? How many multiples have MARS BARS risen? (ie How many times did they go up?)

Lets deflate the £750 GDP in 2013 to 1971 values to remove inflation: Year Price of MARS BARS Number Supplied Inflation between 1971 and 2013 Index values for inflation, using 1971 as base. (= “The Deflator”) GDP Current Prices (Price Mars Bars x Number Supplied) 1971 3p 100 =3/3*100 = 100 £3 2013 75p 1000 =75/3 = 25 or 2500% =75/3*100 = 2500 £750 We want to know how much the value of Mars Bars in the economy has increased, without inflation? Lets deflate the £750 GDP in 2013 to 1971 values to remove inflation: What deflation factors shall we use? We want it to get smaller so 1971 Index / 2013 Index = 100/2500 = 1/25 or 0.04 Now multiply the GDP in 2015 (£750) by the factor (0.04) = 750 x 0.04 = £30 and compare with the £3 GDP in 1971 -> GDP has risen 10 times in REAL terms (not too surprising – the number supplied has risen x10)

Now the other way – ie inflate 1971 to 2013? Year Price of MARS BARS Number Supplied Inflation between 1971 and 2013 Index values for inflation, using 1971 as base. (= “The Deflator”) GDP Current Prices (Price Mars Bars x Number Supplied) 1971 3p 100 =3/3*100 = 100 £3 2013 75p 1000 =75/3 = 25 or 2500% =75/3*100 = 2500 £750 Now the other way – ie inflate 1971 to 2013? What deflation factors shall we use? We want GDP to get bigger so 2013 Index / 1971 Index = 2500/100 = 25 Now multiply the GDP in 1971 (£3) by the factor (25) = £75 and compare with the £750 GDP in 2013 -> GDP has risen 10 times in REAL terms (not too surprising – the number supplied has risen x10)

What is the 1971 GDP expressed at 2013 prices? GDP deflator at market prices Current price GDP Calendar year 2015 = 100 per cent change on previous year GDP £ million 1970 8.044 55,916 1971 8.709 8.27 62,640 1972 9.371 7.6 70,305 1973 10.2 8.86 81,467 1974 11.837 16.04 92,227 1975 14.928 26.11 114,541 1976 17.232 15.44 136,172 1977 19.616 13.83 158,786 1978 21.918 11.74 184,891 1979 25.091 14.48 219,559 2004 80.676 2.44 1,304,874 2005 82.822 2.66 1,379,457 2006 85.267 2.95 1,455,644 2007 87.437 2.55 1,530,890 2008 89.924 2.84 1,564,252 2009 91.287 1.52 1,519,459 2010 92.694 1.54 1,572,439 2011 94.559 2.01 1,628,274 2012 96.011 1,675,044 2013 97.841 1.91 1,739,563 2014 99.451 1.65 1,822,480 2015 100 0.55 1,872,714 FROM HM Treasury! What deflators would you use to inflate current price 1971 GDP to 2013 GDP? What is the 1971 GDP expressed at 2013 prices?

50,000,000,000,000 Mark Note 1923 

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500 000 000 000 dinars (2 years into the Yugoslav civil war)