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

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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?)

8. 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)

9. 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)

10. 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?

11. 50,000,000,000,000 Mark Note 1923 

12. Google “economist zimbabwe after hyperinflation”

13. 500 000 000 000 dinars (2 years into the Yugoslav civil war)