Inflation – Flashcard
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deflation
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decline in economy's price level
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Economic Growth
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an increase in real output (GDP) or real output per capita
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Potential Output
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real output (GDP) an economy can produce when it fully employs its available resources
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Inflation
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rise in the general level of prices in an economy
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Consumer Price Index
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index that measures the prices of a fixed "market basket" of some 300 goods and services bought by a "typical" consumer
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Demand-Pull Inflation
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increases in the price level (inflation) resulting from an excess of demand over output at the existing price level, caused by an increase in aggregate demand
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Cost-Push Inflation
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increases in the price level (inflation) resulting from an increase in resource costs, and therefore in per-unit production costs, caused by reductions in aggregate supply
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Per-Unit Production Costs
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average production cost of a particular level of output; total input / units of output = per-unit production cost
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Anticipated Inflation
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increases in the price level (inflation) that occur at the expected rate
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Unanticipated Inflation
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increases in the price level (inflation) at a rate greater than expected
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Cost-of-Living Adjustments (COLAs)
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automatic increases in the incomes (wages) of workers when inflation occurs; guaranteed by a collective bargaining contract between firms and workers
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Real Interest Rate
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interest rate expressed in dollars of constant value (adjusted for inflation) and equal to the nominal interest rate minus the expected rate of inflation
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Nominal Interest Rate
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interest rate expressed in terms of annual amounts currently charged for interest and not adjusted for inflation
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Deflation
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decline in the economy's price level
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Hyperinflation
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very rapid rise in the price level; extremely high rate of inflation
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Labor Force
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The total number of workers, including both the employed and the unemployed
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core inflation rate
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the rate of inflation excluding the effects of food and engery prices
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quantity theory
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theory that too much money in the economy causes inflation
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wage-price spiral
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the process by which rising wages cause higher prices, and higher prices cause higher wages
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fixed income
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an income that does not increase even though prices go up
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deflation
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a sustained drop in the price level
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causes of inflation
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demand pull theory; cost push theory; quantity theory; wage increase; commodity inflation, core inflation rate
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commodity inflation
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general price increases caused by run-ups in the proces of key goods
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What is the inflation formula
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(CPI Year 2 - CPI Year 1) / CPI Year 1 x 100
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What is headline inflation
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Movements in the CPI based on all elements in the basket - nothing is excluded
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What is underlying inflation
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Movements in the CPI after eliminating one off or unusual movements that will not persist into future periods. This shows the underlying inflation in the economy, as distinct from the headline rate that include all elements of the basket
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What are four types of inflation
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Demand inflation, cost push inflation, imported inflation, inflationary expectations
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What is the target in relation to inflation
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The target is to keep inflation between 2-3% over the course of the economic cycle. Note that the origin of this is NOT in the RBA Act, but in an agreement between the RBA and the government.
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Inflation is important to workers
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Allowing for wage increases
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Inflation is important to business owners because
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It allowes them to increase prices.
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Define inflation
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Inflation is a sustained increase in the general level of prices over a period of time mesured by the CPI
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How is inflation measured?
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Inflation is measured by changes in the CPI over a period of time
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Name five items used in the CPI
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Property, Food, Alcohol, Health, Transport
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Explain cost push inlfation
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Cost push is caused by increases in the cost of inputs into the production process (wages, raw materials) which leads to a decrease in supply and increase in prices in the economy
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Explain demand pull inflation
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Demand pull is caused by an increase in aggregate demand which leads to price pressures
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Explain imported inflation
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Imported inflation results from imports rising in price...this may be a result of a depreciation of currency or higher costs overseas
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Explain how inflationary expectations contribute to inflation
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If consumers and firms expect prices to rise they will increase demand in the current period & cause a rise in aggregate demand
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Distinguish between headline and underlying inflation
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headline inflation measures all items of the CPI whereas underlying removes one off or volatile items from the measurement. The ABS use a trimmed mean also where the top and bottom 15% of items are removed to give a more realistic measure of general price changes
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How would you describe the trend in inflation over the last decade?
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Inflation has remained relatively steady within the 2-3% target band of the RBA, rising slightly higher in 2007-08 but dipping and currently at 1.2% for the June quarter.
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What is the target rate for inflation?
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2%
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What are the positive effects of inflation?
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avoids deflation and issues with real wage rises and a delay in consumer spending. Borrowers on fixed rates also benefit with relatively lower borrowing costs.
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Describe 3 negative effects of inflation
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It can reduce real wages hence standards of living, it can distort resource allocation as investors base decisions on inflationary expectations, it can reduce international competitiveness as exports are more expensive
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What is the short term trade off with inflation?
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Unemployment
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How can monetary policy reduce inflation?
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A tightening of MP leads to higher rates and reduced AD
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How can fiscal policy reduce inflations?
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A contractionary policy reduces economic activity through reduced stimulus in the economy
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What is the role of micro policy in reducing inflation?
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Micro policy creates a more efficient and productive economy increasing AS and hence reducing price pressures as more output is produced with a given set of resources
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How do you calculate the contribution of aspects of the economy to inflation?
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To calculate the contribution of food for example you determine the percentage allocated to food spending by the ABS and multiply by the change in index over time
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Disinflation
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Declining rate of inflation (inflation must be present)
