Transcript Inflation

Inflation
“a sustained increase in the general price level”
1985
Household
income :
10,000/yr
2015
Cost of
Living:
10,000/yr
Household
income:
30,000/yr
Cost of
Living:
30,000/yr
(focus on whole economy - not one particular industry – it’s possible for
individual industry to experience decreasing prices when the economy is
experiencing overall inflation)
Inflation Target
- gov’t has set a target of 2% for inflation – this is
deemed the best rate for a stable economy (higher
than that and inflation can have negative effects;
lower than that can mean a stagnant economy)
As prices rise, the value of money falls – the same
money can’t buy as much as it used to.
The Bank of England is charged with the
responsibility of controlling inflation through changes
in the interest rate.
Measuring Inflation
1. Family Expenditure Survey – find out what
households spend their money on (average
basket of goods – approx. 600)
2. Weights Determined – goods that we spend a
higher proportion of income on get more
importance in the basket
3. Prices Checked – from stores across the UK
4. Weights Applied – price changes multiplied by
the weight of that item
5. Total CPI – weighted price changes are totalled
to give retail price inflation
Calculating CPI
Product
Weight
Fuel
10%
X
+ 20%
=
+ 2%
Food
25%
X
- 10%
=
- 2.5%
Motoring
5%
X
0%
=
0%
Leisure
20%
X
+ 5%
=
+ 1%
Clothing
10%
X
+ 6%
=
+ 0.6%
Housing
30%
X
+ 5%
=
+ 1.5%
100%
Price
Change
Total CPI:
Weighted Price
Change
+ 2.6%
CPI calculation exercise:
Food: +2%
Alcohol, tobacco: +6.1%
Clothing: -0.5%
Housing, utilities: +2.2%
Furniture & household: 1.7%
Health: +2.4%
Transport: +2.5%
Communication: +3.4%
Recreation: +1.2%
Education: +3.2%
Restaurants, hotels: +3.0%
Misc: +2.3%
Product Division
% Price Change
Weight in basket
Weighted price change
Other Measures of Inflation
• RPI – slightly different contents of basket –
importantly, includes mortgage interest
(CPI does not include mortgage interest
payments – this would overstate changes in
interest rates made by the MPC)
• PPI – Producer Price Index – costs faced by
producers (a leading indicator of RPI)
Cost-Push Inflation
• Firms respond to higher costs by
increasing prices (AS shifts inward)
Causes:
↑imported raw
material costs
PL
AS1
AS
↑ labour costs
↑ indirect or direct
taxes paid by firms
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
Costs of Inflation
• Loss of competitiveness: ↓ exports due to
high prices
• Uncertainty: ↓ investment
• Industrial unrest: workers may strike to ↑
wages
• Menu costs: constant changing of prices
costs money (eg. reprinting menus)
Benefits of Inflation
• Reduces real cost of outstanding loans
• Allows for higher wages
• Decreased real cost of borrowing MAY
increase investment