Economics: Unemployment and Inflation

Questions and Answers

Define Demand Pull Inflation.

Demand-pull inflation occurs when aggregate demand within the economy increases. Often, the economy is almost at their productive capacity, and therefore, instead of increasing productivity and supply, there is a price increase, resulting in inflation.

Define Cost Push Inflation.

Cost-push inflation occurs when the costs of production are increased (e.g., wages or oil) and the supplier forwards those costs onto consumers.

Define Inflation.

Inflation is a persistent and appreciable rise in the general level of prices.

How is Inflation Measured?

The most widely used measure of inflation in Australia is the Consumer Price Index (CPI), which is compiled on a quarterly basis. Signup and view all the answers

What is the equation for the measurement of Inflation?

The equation is: $\frac{CPI_2 (yr 2) - CPI_1 (yr 1)}{CPI_1 (yr 1)} \times 100$. Signup and view all the answers

Define Demand Pull Inflation in another context.

A situation where the level of prices is rising because of excess demand in the economy at the full employment level. Signup and view all the answers

Define Cost Push Inflation in another context.

The situation where price rises are caused by cost pressures, independent of the level of aggregate expenditure. Signup and view all the answers

Where does Demand Pull Inflation Originate?

From consumers (wage rises, interest rate cuts), firms (business optimism), government (budget deficit), or overseas (rising demand for exports). Signup and view all the answers

Where does Cost Push Inflation Originate?

From rises in the price of factors of production, rising import prices, or increased key raw materials like oil. Signup and view all the answers

What are some examples of Demand Pull Inflation?

The Building Boom (2004-2006) and the Mining Boom in WA. Signup and view all the answers

Define Headline Inflation.

Includes the effects of seasonal factors, interest rate changes, and other policy influences, which can be misleading. Signup and view all the answers

Define Underlying Inflation.

Also known as the 'core rate', excludes seasonal factors and other policy changes to measure the 'true' rate of inflation. Signup and view all the answers

What are some issues with using CPI as a measurement of Inflation?

CPI does not reflect price movements outside metro areas, consumer preferences, or changes in quality over time. Signup and view all the answers

What are the effects on output of Inflation?

Inflation affects income and employment levels, reduces purchasing power, promotes uncertainty, and can lead to economic collapse in extreme cases. Signup and view all the answers

Study Notes

Demand Pull Inflation

Occurs when aggregate demand increases in an economy.
Prices rise instead of increasing productivity and supply due to near full capacity.

Cost Push Inflation

Arises when production costs (e.g., wages, oil) escalate.
Producers pass increased costs onto consumers, leading to inflation.

Inflation

Persistent, appreciable rise in the general price level.

Measurement of Inflation

Consumer Price Index (CPI) is the primary measurement in Australia.
Compiled quarterly, summarizing overall price changes of various goods and services.
Inflation is calculated using the formula:
(CPI 2 - CPI 1) / CPI 1 x 100

Demand Pull Inflation Characteristics

Price rises result from excess demand in a fully employed economy.
Driven by factors such as high aggregate expenditure, wage rises, and government budget deficits.

Cost Push Inflation Characteristics

Price increases due to independent cost pressures, regardless of aggregate expenditure levels.
Factors include increased production costs, rising import prices, and higher government charges.

Origins of Demand Pull Inflation

Consumer actions: wage rises, interest rate cuts, tax cuts, and increased wealth.
Firm behaviors: business optimism and interest rate cuts.
Government actions: budget deficits financed by borrowing.
International factors: rising demand for exports or export prices.

Origins of Cost Push Inflation

Rises in production factor prices, like wages exceeding productivity gains.
Increased import costs possibly due to currency depreciation.
Escalation in prices of key raw materials (e.g., oil).
Rising government taxes and charges.

Examples of Demand Pull Inflation

Building Boom (2004-2006) caused a shortage of skilled tradespeople.
Mining Boom in Western Australia led to inflated pay rates in mining jobs.

Headline Inflation

Incorporates seasonal factors and influences from interest rate and policy changes.
Can be misleading as it includes price movements not reflective of core inflation.

Underlying Inflation

Known as the 'core rate' and excludes data from seasonal factors and policy changes.
Provides a clearer measure of the 'true' inflation rate by removing volatile elements.

Issues with CPI as a Measurement

CPI may not accurately reflect price changes outside urban areas.
Fails to account for changing consumer preferences affecting the cost of living.
Does not factor in changes in product quality over time, potentially overstating inflation.
Despite limitations, CPI remains a crucial macroeconomic indicator influencing pensions, contracts, and government policies.

Effects of Inflation on Output

Affects overall income, employment, and output levels in the economy.
Reduces consumer purchasing power and economic efficiency.
Creates uncertainty, discouraging savings and investment.
Can lead to capital for labor substitution and erode confidence in currency.
High inflation relative to trade partners can worsen the Current Account Deficit (CAD).
Hyperinflation risks economic collapse.

Benefits of Low Inflation

Helps to maintain lower interest rates.
Improves international competitiveness for Australia.
Sustained low inflation can promote currency value stability.

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Test your understanding of key economic concepts such as demand-pull and cost-push inflation with these flashcards. Each term is defined clearly to help you grasp their implications in real-world economics.