1. Chapter 21

2. Inflation
Inflation is defined as a steady and persistent increase in the general level of prices. It’s the rate at which your money loses its ability to buy things.

3. Measuring Inflation Simple price index: Price in any year
Price in base year x 100

4. Five Steps to Create a Composite Price Index
Choose a base year and let all the prices equal 100.
Select the goods and find the prices for all goods in all years.
Construct a simple price index for each good.
Multiply the simple price index by the weight (proportion of income spent on the good).
Add to get the composite price index for the current year.

5. Consumer Price Index (CPI)
The consumer price index is the official measure of inflation in Ireland. It measures the price changes of goods and services typically consumed by all consumers living in rural/urban areas, high-/low-income earners and from all age groups. It is a price index that shows the current cost of purchasing the same identical basket of goods with the base year (starting point).

6. What are the Economic Uses of the Consumer Price Index?
Measures the rate of inflation
International comparisons
Indicator of the country’s/government’s performance
Indexation of savings and investments
Used in wage negotiations
Used by government to index tax bands

7. What Precautions Should be Taken When Using the CPI?
An index of the average consumer
Not a cost of living index
Lags behind consumer trends and fashions
Static weights
Quality changes in products
Substitution of products

8. What Factors Cause Inflation?
Demand pull factors
Cost push factors
Imported inflation
Government-induced inflation

9. What Remedies are Available?
Fiscal policy
Monetary policy
Partnership agreements

10. What Problems are Caused by High Inflation?
Lower standard of living
Speculation is encouraged
Borrowing is encouraged
Wage demands
Loss of international competitiveness
Saving is discouraged
Difficulty attracting foreign direct investment
Increase in unemployment

11. Deflation
Deflation happens when there is a general decrease in the average level of prices. This sounds great, but it can damage an economy. If all prices are steadily declining, then consumers may postpone buying goods and services, expecting it to cost less a week later and less again a month later, causing consumer demand to fall and thus affecting employment and growth (e.g. house prices at present in Ireland). Likewise, a company might postpone investing and the economy would suffer.

12. Benefits of Price Stability
Consumers will tend to spend, generating demand for goods and services and hence employment, contributing to economic growth.
The demand for wage increases won’t be as urgent given that workers’ purchasing power isn’t falling. This in turn keeps costs stable and companies may decide to increase investment given that they are able to plan more effectively.

13. Benefits of Price Stability cont.
Old-age pensioners and those on fixed pensions will see their purchasing power being maintained and will be able to manage better.
Savings in the economy may increase, leading to investment (if the rate of inflation is less than the rate of interest).
Government revenues could increase with more indirect and direct taxes being collected due to increased numbers of people working and spending.

14. Constant Tax Price Index
The constant tax price index is a price index that keeps the indirect tax part of a price increase constant. The main use of this index is in wage negotiations. It will reduce the possibility of employees getting wage increases to compensate for increases in taxation.