Inflation | Notes

How is inflation measured?

Inflation is measured using the CPI (Consumer Price Index)

It tracks the prices of a weighted basket of goods and services in the UK.

What is inflation?

A rise in the average price level.

What is deflation?

A fall in the average price level.

What is disinflation?

When the rate of inflation slows down (but remains positive) e.g. from 5% to 2%

The two causes of inflation

1. Demand pull inflation (AD shifting right)
2. Cost push inflation (AS shifting left)

The impact of high inflation

1. inflation is a rise in average price level
2. if we assume that wages do not rise at the same rate as prices
3. consumers have less disposable income
4. living standards fall
5. workers ask for a pay rise
6. firms have two options
   1. offer higher wages and then raise prices again (wage-price spiral)
   2. firms pay the higher wages but then layoff workers

The impact of deflation

1. deflation is a fall the average price level
2. people form expectations that prices will continue to fall
3. consumers delay spending
4. lack of demand for goods and services
5. labour is a form of derived demand so firms will layoff workers as they expect to produce less output
6. incomes and consumption could fall even more, leading to further deflation (negative multiplier effect)

Summary questions

1. How is inflation measured?
2. What is inflation?
3. What is deflation?
4. What is disinflation?
5. The two causes of inflation
6. Why is the inflation target is 2%?
   1. What is the impact of high inflation?
   2. What is the impact of deflation?