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Inflation (Consequences (Redistribution effects (Losses to
Holders of…
Inflation
Define:
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*Disinflation is the fall in the rate of inflation; involves a positive rate of inflation in contrast with delfation*
*Stagflation is when there is persistent high inflation combined with high unemployment and stagnant demand in a country's economy*
Consumer price index
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Limitations
- Different income groups consume different combinations of g's and s's. Thus, they face different inflation rates than those calculated in the basket
- The quality of products may improve over time. The CPI cannot account for this
- Consumers are increasingly using discounts or sales. The CPI cannot account for this as prices are lower than those in the calculations
- Changes in consumption patterns due to consumer substitutions when relative prices change -- Results in changing weights as g's and s's prices fluctuate causing the consumer to change buying habits
- Cross country comparison is not possible due to differing CPI's -- types of g's and s's bought.
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The more of the product consumers consume the more 'weight' it will have in the basket.
e.g. Consumers buy one iPhone a year v fruit weekly
Other ways to measure
Producer Price Index
It measures change in the avg. prices of FOP's thus, PL changes from producers perspective not consumers. As the PPI measure PL changes at early stages in production, it is useful in predicting changes in future inflation.
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Consequences
Redistribution effects
- Losses to
- Holders of cash, savers, lenders and people receiving fixed income / wages as the REAL VALUE falls
- Gains to
- The borrowers and payers of the fixed income / wages. As the REAL VALUE of their payment falls therefore, essentially, they gain money.
Some may be avoided through:
- Payment of interest to savers and lenders that is at least as high as the rate of inflation.
- Increases in income or wages that is at least as high as the rate of inflation.
Uncertainty
Inability to predict future prices and PL changes cause uncertainty among firms who cannot accurately predict future revenues and costs of production = negative effect on investments = economic growth
Menu costs
High rates cause restaurants or firms to have to reprint menus, catalogues etc. which only increase their costs of production
Less saving
As they lose real value thus, they lose the incentive to save ( if interest is not high enough)
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Types and causes
Demand pull
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Gov policies
Contractionary fiscal policy: G:arrow_down:, T:arrow_up:
- Effective in addressing high and rising inflation
- G is a component of AD. Decrease impacts the economy
- Time delays, politically unpopular, political interference
Contractionary monetary policy: Interest rate :arrow_up: = C:arrow_down: and I :arrow_down:
- Quick
- No political interference
- Higher interest rates may affect AD after time lag
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Cost push
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Gov policies
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Supply-side policies: Appropriate but face time lags.
- If it is due to rising wages, the policy should aim at stopping the wage increase.
- If it is due to rising profit due to excessive monopoly power, policies should aim to decrease monopoly power of firms
- It is due to a depreciating currency (import prices rises for domestic buyers), policies should aim to reduce dependence on imports
- If it is due to increasing prices of oil or food, policies should aim to reduce oil dependence
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