Economics Chapter on Inflation

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Questions and Answers

What is the primary characteristic of inflation?

  • A sustained decrease in the general price level over time.
  • A fluctuating price level with no clear trend.
  • A sustained rise in the general price level over time. (correct)
  • A period of falling prices followed by a period of rising prices.

Which term describes a situation where the rate of inflation is decreasing?

  • Disinflation (correct)
  • Deflation
  • Inflation
  • Stagflation

If a country’s economy grew by 5% in a year, but inflation was 3%, what was the real economic growth?

  • 5%
  • 2% (correct)
  • 15%
  • 8%

What is a key trigger for demand-pull inflation?

<p>A depreciation in the exchange rate. (B)</p> Signup and view all the answers

What is the definition of nominal GDP?

<p>The value of GDP without being adjusted for inflation. (D)</p> Signup and view all the answers

Which situation best describes cost-push inflation?

<p>An increase in production costs for businesses (C)</p> Signup and view all the answers

If the average price level in an economy falls, what is this phenomenon called?

<p>Deflation (B)</p> Signup and view all the answers

A fiscal stimulus is MOST LIKELY to contribute to which type of inflation?

<p>Demand-pull inflation (B)</p> Signup and view all the answers

Which of the following is a direct consequence of an increase in the price of raw materials?

<p>A rise in cost-push inflation (A)</p> Signup and view all the answers

How can trade unions contribute to inflation?

<p>By advocating higher wages which increase labor costs (C)</p> Signup and view all the answers

What is a potential impact of a depreciation in the exchange rate on inflation?

<p>Imports become more expensive, causing inflation (A)</p> Signup and view all the answers

Which action by a central bank is a direct example of quantitative easing?

<p>Printing more money to buy government bonds (C)</p> Signup and view all the answers

Under what circumstance would an increase in the money supply be most likely to cause inflation?

<p>If the increase in money supply is faster than real output growth (C)</p> Signup and view all the answers

How are individuals with a fixed income affected by inflation?

<p>Their real income decreases (D)</p> Signup and view all the answers

How does inflation affect the real value of debt?

<p>It decreases the real value of debt (B)</p> Signup and view all the answers

What is a potential effect of monopolies on inflation?

<p>Monopolies may exploit consumers with higher prices, potentially contributing to inflation (D)</p> Signup and view all the answers

Flashcards

Inflation

A sustained increase in the general price level over time, leading to a decrease in the purchasing power of money.

Deflation

A sustained decrease in the general price level over time, leading to an increase in the purchasing power of money.

Disinflation

A slowdown in the rate of inflation, meaning prices are still rising but at a slower pace.

Nominal Value

The value of economic data without any adjustment for inflation.

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Real Value

The value of economic data adjusted for inflation, reflecting its real purchasing power.

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Demand-Pull Inflation

Inflation caused by excessive demand in the economy, pushing up prices.

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Cost-Push Inflation

Inflation caused by rising production costs, pushing up prices.

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Real GDP

The measure of economic growth adjusted for inflation, reflecting the true increase in output.

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Rising Raw Material Costs

An increase in the cost of raw materials, like oil, which makes goods more expensive to produce.

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Rising Labor Costs

A situation where workers demand higher wages, often due to trade unions, which can lead to higher production costs and inflation.

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Inflationary Expectations

When consumers expect prices to rise, they may demand higher wages to compensate, potentially triggering a cycle of rising prices.

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Indirect Taxes

Taxes imposed on goods and services, such as fuel or cigarettes, that can increase production costs and ultimately lead to higher consumer prices.

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Depreciating Exchange Rate

A weakening currency makes imported raw materials more expensive, leading to higher prices for the final goods.

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Monopolies

Companies with a dominant market position may exploit consumers with high prices, contributing to inflation.

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Growth of Money Supply

An increase in the money supply, without a corresponding increase in real output, can lead to inflation. This happens when there is more money chasing the same amount of goods.

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Study Notes

Inflation

  • Inflation is a sustained rise in the general price level over time, reducing the purchasing power of money.
  • Deflation is the opposite, where the average price level falls, and there is a negative inflation rate.
  • Disinflation is when the average price level is rising, but at a slower rate.

Distinction between Money Values and Real Data

  • Nominal value is the money value of data.
  • Real value is the data adjusted for inflation.
  • Real GDP is the GDP adjusted for inflation, indicating the true economic growth.
  • Nominal GDP is the GDP without inflation adjustment, potentially overstating growth.

Causes of Inflation

Demand-Pull Inflation

  • Occurs when aggregate demand grows unsustainably, putting pressure on resources.
  • Causes include:
    • Depreciation in exchange rates (imports more expensive, exports cheaper)
    • Fiscal stimulus (lower taxes, increased spending, increasing disposable income)
    • Lower interest rates (encouraging spending and borrowing)

Cost-Push Inflation

  • Occurs when firms face rising costs.
  • Causes include:
    • Increased raw material prices (e.g., oil)
    • Increased labor costs (e.g., wage increases)
    • Expectations of inflation (higher wages to compensate)
    • Indirect taxes (e.g., on fuel or cigarettes)
    • Monopolies exploiting market power

Growth of Money Supply

  • Excessive increases can lead to hyperinflation—uncontrollable rapid inflation.
  • Relevant in cases where money supply grows faster than real output.
  • Quantitative easing (QE) is a tool used by central banks to stimulate the economy, increasing money supply and lowering interest rates.

Effects of Inflation

Consumers

  • Low and fixed incomes are most affected by inflation due to its regressive nature.
  • Cost of necessities (food, water) becomes a bigger issue.
  • Inflation reduces the real value of debt (if loans are not adjusted)

Firms

  • Low interest rates may encourage investment, however, higher interest rates are more likely during high inflation decreasing investment.
  • Price competitiveness can decrease if inflation is higher than in competitor countries.
  • Uncertainty about future costs can reduce investment.

Workers

  • Real incomes fall with inflation, leading to lower disposable income.
  • Increased costs for firms could lead to redundancies.

Government

  • Government payments need adjustment to compensate for rising costs during inflation.

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