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Chapter 3.4 - Price Stability (Cost Push Inflation (Cost push inflation -…
Chapter 3.4 - Price Stability
Cost of living and the general price level
Cost of living
- Spending on goods and services bought by the average family
When price rises, cost of living increases, people's money will not buy as much as before. The quality of life will fall.
The price level
- The average of current prices across all goods and services
Definitions
Rate of inflation
- The percentage rise in the general price level over time
Price stability
- The general level of price is kept constant OR grows at an acceptably low rate over time
One of the key government objectives
-In practice it's not 0% but 2% per annum in UK
Inflation
- A sustained rise in the general price level over time
When on average prices of goods and services in the whole economy are rising - however some individual products may still fall (e.g technology becomes cheaper/prices rising)
Inflation
How is it measured
Government complies a "basket" of typical products
Government records prices of products at hundreds of retail outlets
Government considers spending of an average household
All prices are recorded, put together and given the number 100 at the start of the period
If prices rise - reflected in index - say if rise 2% index = 102
Consumer price index (CPI)
- an index that measures changes in the general price level of typical consumer goods and services
Real VS Nominal Values
Nominal value
- a face value of something expressed in money terms
If inflation is higher than nominal increase in income, real value of income falls, people won't be able to buy as many goods or services
Real value
- takes into account the effect of inflation
If inflation is higher than nominal GDP, real value of GDP falls. Economy produces lower value goods of services
Demand- Pull inflation
Demand pull inflation
- When aggregate (total) demand in the economy rises and the supply of goods and services does not increase to match it. Price level is pilled up
Government spending
Consumers in foreign countries
Firms demanding capital goods for investment
Cost Push Inflation
Cost push inflation
- When rises in costs of production cause firms to increase prices, raising the overall price level in the economy
If costs rise, firms will raise prices to maintain their profits, raising price level
Wages and salaries
Raw macterials
Fuel -oil,coal
Rent and buisness taxes
Interest on loans
Causes of inflation Cost-Push
Wage price spiral
Initial rise in general price level
1.Workers demand higher wages to compensate
2.Wages paid to workers rise
3.Costs of production to firms rise
4.Firms put up prices of goods and services
5.General price level rises further
Productivity of labour
Productivity
- output per worker per period of time
Productivity rises -> Cost per unit falls -> firms produce more _> sell more -> more revenue
Consequences of inflation
Consumers
Real incomes fall
- consumers have limited income - inflation affects income - wage rises less than rate of inflation - cost of living increases - standard of living falls
Index united income
: income that keeps up with inflation, standard of living is the same
Shoe leather costs
- Price change more often - more time/effort spent by consumers looking to purchase goods
Income redistribution problems
Debtors gain from inflation
Savers lose from inflation
Strong trade union - wages rises up with inflation
Low paid occupants - weak bargaining power
Low fixed incomes struggle
Debtors - gain in inflation
- real value of debt goes down - debt is cheaper - higher rate of inflation
Producers
Menu Costs
- firms adjust price lists more often - costs for firms - capital equipment changed more often
Labour market conflicts
- workers trade unions aware inflation is reducing purchasing power of money wages - want money wage rise to keep up inflation - so real wage doesn't fall
More flexibility
- inflation in growing economy - greater flexibility for firms - easier for relative prices to adjust
Wages- price of labour
Low inflation
- business increase prices - consumers less likely to realise when general prices rise - remain competitive
Unemployment
- Uk economy less competitive - leads to unemployment - less goods sold abroad - less output - less workers
Producers lose as creditors
- debtors replay loans (ie to banks) - real value is lower
Produces lack business confidence
- businesses less likely to invest if uncertain - adverse effects of economic growth
Savers
Purchasing power of money falls
- money kept as savings - lose value in real terms of inflation - lose money
Government
Government gains as debtor
- net borrower (debtor) - owes money to individuals/institutions
Government spends more as a provider of benefits -operates social protection system (ie benifits) - raise with inflation, are index linked
Government spends more as a major provider
- major employer of workers ie. school - faces demand for wage rises - will raise finance for this
Government receives more in tax
- collects more revenue - prices money wages rise - receive higher revenue automatically
ie. VAT if government does nothing - smaller amount of tax collected
Government policy needs to combat inflation
- drastic consequences if not managed - policy to control inflation