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?
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What is the equation for the measurement of Inflation?
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Define Demand Pull Inflation in another context.
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Define Cost Push Inflation in another context.
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Where does Demand Pull Inflation Originate?
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Where does Cost Push Inflation Originate?
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What are some examples of Demand Pull Inflation?
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Define Headline Inflation.
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Define Underlying Inflation.
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What are some issues with using CPI as a measurement of Inflation?
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What are the effects on output of Inflation?
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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.