Inflation - Level 2 Economics
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Inflation is a general increase in the price level over a period of time
Describe what is meant by deflation
Deflation is a general decrease in price levels
A fall in the inflation rate
Explain how CPI can rise when prices of some goods are falling
The good or service is an individual market. CPI measures average prices changes over a number of markets. So while prices of some goods or services are falling there can still be a rise in most goods and services so CPI will rise
Explain how lower interest rates cause inflation
Lower interest rates result in less savings and increased comsumption spending by households and increased investment by firms, this will cause AD to increase causing inflation
Explain how a depreciation of the New Zealand Dollar causes demand-pull inflation
A fall in the New Zealand dollar results in exporters swapping foreign earnings for more New Zealand Dollars. This increase in earings enable more spending so causes AD to increase therefore inflation.
Explain how depreciation of the New Zealand dollar causes cost-pull inflation.
A fall in the New Zealand dollar results in an increase in the cost of imported raw materials. An increase costs faced by firms will cause AS to decrease and cause inflation.
Explain why an increase in the price of a vegetable is less likely to cause inflation than an increase in the price of petrol.
A rise in the price of a vegetable only affects one market, whereas a rise in the price of oil affects many different markets through higher transportation costs, so more likely to lead to a rise in the general price level therefore inflation.
Explain how a rise in bussiness confidence will impact of the rate of inflation.
A rise in business confidence will lead to increased investment, causing AD to rise, and inflation.
Describe the relationship sugested by the equation of exchange between money supply and the rate of inflation.
As money supply increases the rate of inflation also increases.
Refer to the variables in the equation of exchange to explain one way inflation might occur, even if the money supply was held constant.
The velocity of circulation might increase, or output in the economy might fall.
Identify three negative impacts of inflation on households.
- -Income becomes less evenly distributed
- -As income increases you move into a higher tax bracket
- -Savings have less spending power
- -Decrease in spending power for those on benifits
Identify 3 negative impacts of inflation on firms
- -Risings costs (wages, raw materials, interest rates)
- -Difficult to replace old equipment
- -Planning difficulties
- -Exports less competitive
- -Less investment.
Explain how an increase in the rate of inflation would impact on overseas trade (exports and imports).
- -Exports are mroe expensive to overseas buyers so exprt reciepts might fall
- -Exports are less competitive
- -Imports are cheapers so import payements will rise
- -Local producers products become more expensive compared with imports so demand for them goes down.
List several events likely to cause cost-push inflation
- -Increase in nominal wages
- -Inrease in indirect tax
- -Decrease in workers productivity
- -Depreciation of the New Zealand Dollar
List several events likely to cause demand-pull inflation
- -Increase in inflationary expectations
- -Increase in consumption spending
- -Increase in business investment
- -Reduced direct tax
- -Increase in govt spending
- -Increase in net exports
Define cost-push inflation
A situation where the process of rising prices is initiated and sustained by increasing costs of productions which push up he general prices level.
Define demand-pull inflation
A situation where demand exceeds supply at current prices, so prices are pulled up by aggregate demand. OR prices rising due to an aggregate demand.
Identify what each letter represents in the equation: MV=PQ
- M= Money Supply
- V=Velocity of circulation
- P=Price Level
- Q=Real output/the quantity produced
(i) identify the stage of the business cycle where the real output (Q) is likely to be constant.
- (i) Boom Phase
- (ii)At the top end of the business cycle when the economy is near full capacity resources are most full employed and real output cannot expand further, Q may be relatively constant.
Explain impact of inflation on savers
Savers may lose out because inflation decreases the real value (purchasing power) of savings
Explain positive impact of inflation on borrowers
Borrowers may benifit because if inflation is high the real value of the borrowed ammount decreases.
Define aggregate supply
Total production by all firms in an economy
Explain the effect of an increase in the cost of raw materials on the AS curve
An increase in teh cost of imported materials will increase firms's costs of production causing AS to shift inward (left)
Stages of the business cycle
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