1. Chapter 17 Inflation and the Phillips Curve
A2 Economics
Mr. Miah

2. Chapter introduction Key word test: inflation, deflation, reflation
Changes in UK rate of inflation
Theories for the causes of inflation
Phillips curve analysis
Costs and benefits of inflation
L.O: Secure our understanding of key inflationary terms.

3. Distinguishing between inflation, deflation and reflation
Inflation: a persistent or continuing rise in the price level, or fall in the value of money.
Deflation: the opposite, persistent tendency for the price level to fall; involving a rise in the value of money.
Reflation: increase in economic activity and output, reflationary policy stimulates AD.
What policies can be encouraged to boost reflation?
ANS: increasing money supply, reducing taxes, lowering interest rates.

4. Key inflationary terms
What is CPI?
A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.
The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance.
Changes in CPI are used to assess price changes associated with the cost of living.

5. Key inflationary terms
What is RPI?
One of the two main measures of consumer inflation produced by the United Kingdom's Office for National Statistics.
The Retails Price Index (RPI) was introduced in the U.K. in 1947, and was made official in Like the Consumer Prices Index (CPI), the RPI tracks changes in the cost of a fixed basket of goods over time, and is produced by combining about 180,000 price quotes for over 650 representative items.

6. What is the difference between RPI and CPI
Both RPI and CPI measure inflation. Both of them do it by taking a basket of goods – food, clothes, petrol - looking at what they cost last year, looking at what they cost now, and finding the proportional difference.
But the CPI leaves the costs of your home out of the basket – so rises in mortgage payments, rents, and council tax, which in real life you pay, don’t get reflected in it. However, the RPI does take account of those costs.
There is a mathematical difference as well. The RPI calculates its ‘proportional difference’ using the arithmetical mean between the old price and the new, the CPI uses the geometric mean. The end result is that the RPI always gives a bigger figure for inflation than the CPI.

7. So what’s CPI and RPI?

8. A bit of history: Changes in the UK inflation rate
Until 2003, the UK government measured changes of inflation with the Retail Price Index (RPIX); this measures the underlying rate of inflation.
BUT, now the government use Consumer Prices Index (CPI).
CPI is defined as the UK price index most central to UK monetary policy.

9. The current position of Inflation in the UK
Article from the BBC
Highlight the key information
Interpret the article:
Current UK inflation position
Movement of inflation
Reasons to fluctuation in inflation rate

10. Calculating price index to measure inflation
Two main tasks are undertaken to construct CPI and RPI:
Sample of good
Weighting goods in the sample
ONS: ‘shopping basket’ theory for CPI and RPI on page 252 and 253.
Discuss and identify the definitions of each term using the ‘shopping basket’ theory.

11. Case Study 17.1 Changes in the National Shopping Basket
In pairs, discuss and answer the follow-up question on page 253.
Think – Pair - Share

12. Theories on the causes of Inflation
Draw Table 17.1 – Theories on the causes of inflation
Then comment on the development of inflation from the 18th century to modern times.

13. The old quantity theory of money
Definition: a theory that assumes inflation is caused by a prior increase in the money supply.
Oldest ‘theory’ of money and a demand-pull theory.
IMPORTANCE:
Presently, quantity theory of money occupies a central place in context to inflation and deflation.

14. The old quantity theory of money
The theory (old or new) are both based on a the demand-pull inflation.
In its simplest form, the quantity theory of money is at times it is described as too much money chasing too few goods.
Starting point to develop this theory is:
Money Supply × Velocity of circulation = Price level × Total transactions
MV = PT
This is known as the Fisher equation of exchange

15. Exam Tip
*Understand the difference between demand- pull and cost-push inflation.
Video explanation
Explain the difference between demand-pull and cost-push inflation.
Video: Depict AD/AS graphs to explain both theories, using any relevant examples. This will be marked.

16. How does this formula relate to inflation?
Necessary assumptions are needed:
Velocity of circulation OR speed at which money is spent are both fixed or at least stable.
Money is a medium of exchange, but not a store of value – what does this mean?
Means people quickly spend any money they receive.
Summary of Quantity Theory – pg. 255

17. What is the link between Quantity theory and Demand-pull theory of inflation pg. 256-257
Q. What are the Similarities and Differences between the quantity theory of money and demand-pull theory of inflation?
Similarities: Both theories explain inflation in terms of excessive demand; pulling-up average price level.
Differences: Key difference is the underlying cause of excess demand:
Monetarist believe government is responsible
Keynesians see it as too much consumer spending

18. Use of AD/AS diagrams to show inflation
Draw AD/AS diagram and explain using your own words.

19. The Keynesian cost-push theory of inflation
Page 258: THINK-PAIR-SHARE
Draw the cost-push inflation figure 17.4 and explain.

20. What is the Phillips curve?
You will produce a presentation answering the following:
Definition and purpose of the Phillips curve
Its historical presence in the economy
Explain the Phillips curve relationship
Distinguish between short-run and long-run Phillips curve

21. What is the Phillips curve?
Definition: the curve is based on evidence from the economy that shows the relationship between the rate of inflation and level of unemployment.
There’s a direct relationship with inflation and unemployment.

22. Continuation of Phillips Curve
RECAP
Video on the Phillips Curve
Q. According to the video, what are the two main causes of inflation?
Q. Explain the relationship between inflation and unemployment.

23. Theory of expectations-augmented Phillips curve and the NRU
Read page and summarise what is meant by:
Expectations-augmented Phillips curve
National rate of unemployment (NRU)
Explain, in detail with the use of figure 17.7, the concept of long-run and short-run Phillips curve.
*EXAM TIP: Must understand difference, and relationship, between short-run and long-run Phillips curves.

24. Possible problem of price deflation
Page
Figure 17.8:
A good deflation diagram
A bad deflation diagram

25. Consolidating notes from Tuesday
Inflation psychology
Possible problem of price deflation
Costs and benefits of price deflation
*EXAM TIP: essay questions may ask for explanation of the costs and benefits of inflation, followed by assessment of whether costs exceeds the benefits.
**THIS FINISHES OFF CHAPTER 17**

26. End-of-chapter exam style question
January 2012
02 Extract B (line 10) suggests that ‘there is often a trade-off’ between inflation and economic growth.
Explain why there might be a trade-off between inflation and economic growth and analyse one cause of inflation. (10 marks)