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Inflation Sungbin, Jerry, Hanson, Amit and Daiki - Coggle Diagram

- - - - A CPI will include any sales tax and excise taxes paid by consumers when buying goods and services. However, it does not include changes in income taxes. The prices of oil, electricity, gas and food. This is because prices can be high and low and could. change rather easily. It could be because of weather changes which could cutback crops for example.
      - The rate of price inflation is measured by calculating the average percentage in price change for all goods and services. As it is hard to constantly calculate the price changes of at least a million of different goods and services, governments will only track a selection of goods and services which will be normally purchased by a typical family. These basket of goods and services will be monitored in a few different retail outlets which also includes online retailers. This information will create a consumer price index (CPI). A CPI can even provide a cost-of-living-index. This index will indicate how much we need to spend in order to purchase the same things we bought in an earlier period.
    - - The base year refers to the first year in which the average price of the selection of these particular goods and services is first calculated, the base year is given 100. For example, if the next year these goods increase by 25% in price, the price index will be 125 at the end of the year. If in the 2nd year, it increases by 10% it will become 137.5 (125 x 1.10).
      - The formula to calculate CPI. CPI in year 1= Weighted average price in year1/ weighted average price in base year x 100
    - - As an economic indicator. It is widely used as a measure of price inflation and is therefore used as a measure of changes in the cost of living. Governments will try combat inflation with macroeconomic policies. It would be used by workers to increase their wages that would match or exceed the cost of living. It would also be used by entrepreneurs in making business decisions such as purchases and setting of wages and prices of goods.
      - As a price deflator. We know that price inflation could reduce the purchasing power of money and real incomes. Hence, wages, pensions, savings and tax revenues etc will decrease in power. A CPI is used to deflate other economic factors to calculate their inflation free values. For example, if annual earnings increase by 10% but price inflation increases by 15% during the same period too, then the real value of earnings would have only fallen by 5%.
      - Indexation. Indexation involves tying certain payments to the rate of increase in price inflation to keep their real value constant. For example, public pensions paid to retired people may be indexed so that they increase based on the rate of inflation each year. This could be also applied to savings which may be index linked. Many workers may be covered by collective bargaining agreements which allow their wages to be index linked. A government would also use this on income thresholds so people do not pay more taxes due to price inflation although their real incomes remain unchanged.
    - - Over time what goods the typical household would buy would change. A CPI will need to take account of these changes but deciding how and when to make them can be difficult. CPI would also have to take account to the changes of the quality of goods and services, how and where households buy goods and services and also including the new shops and online stores. Furthermore, international comparisons of consumer price inflation can vary from country to country due to various spending patterns and household composition.
  - - - If price of goods and services included in the basket of CPI fall over time, the CPI will therefore also fall.
- - - - There is a monetary rule that states that "a government should only allow the supply of money to expand at the same rate as an increase in real output or real GDP
      - If not, then excessive growth in the money supply will cause inflation. This will increase the aggregate demand of products at a faster rate than aggregate supply, leading to demand pull inflation
    - - This is inflation caused by excessive aggregate demand that exceeds aggregate supply. This will force firms and businesses to raise their prices to lower demand while ensuring profits and supplying the same amount of goods
      - This is generally the most common type of inflation. For example, following the increase of employment and economic growth, more workers are earning money through wages. This creates an increase in disposable income and subsequently consumer spending and aggregate demand. However this large increase in demand causes demand pull inflation as some firms are unable to supply.
    - - This is inflation caused by rising production costs passed on by firms to the consumers. This happens in the supply side of the economy. Its when rising production costs prompts firms to raise the selling price of their goods and services. This is to ensure that they can cover the rising costs production.
      - An example of this is the rising costs of wages due to factors unionization efforts. Firms will have to pay more money for their wages, and in order to cover the added costs, they must increase the price of their goods and service in order to keep the profits the same.
    - - This is when rising import prices from one country gets transported to another through international trade.
      - This is because of the affect that exchange rate has on import prices. For example, if the exchange rate of Singapore to Indian Rupees drops from 1:50, to 1:25, then a product from India costing 500 rupees will increase from $10 to $20 SGD
  - - - When market supply increases more than the demand, firms will decrease the market price in order to try to increase the real demand for the product. By doing this, the market price decreases, contributing to deflation.
    - - A decrease in market demand of a product will mean that the firm has to decrease the market price in order to increase demand to sell the product. This will therefore lead to deflation
    - - When a firm has competition, they decrease the market price of their price to lower than the other in order to win over the demand for the product in a perfect competition. This will happen over and over on both sides, decreasing the market price.
    - - An increase in labour productivity will lead to an increase in output of the goods and also reduced average cost of production. With this, the market price of each good will be decreased by the firm to sell more, while also increasing the market supply and causing deflation.
    - - Technology reduces the demand for labor through technological and structural unemployment. This creates downward pressure on wages nd employment levels. This in turns reduces the amount of disposable income that the average worker has, therefore decreasing consumer spending and aggregate demand.
      - Technological advancements create less demand for other goods and services, making them less redundant. For example, the increased use of online search engines and information on the web decreases the need for learning and education through buying books. This creates less aggregate demand in these areas, causing deflation
- - - - Not effective, as real interest rates will be rising even if the nominal interest rate is low. For example, even if the nominal interest rate is 0%, once someone puts $1000into saving for a year, and deflation is at 5% per year, by that year, because of the deflation, their $1000 will be worth around $1050 as price of goods fall and the buying power of the currency increases. This still encourages saving even if there are low nominal interest rates
    - - Done to encourage spending hence increasing demand. The money supply can also be used by government to fund projects to increase employment. With increased employment, there will be higher disposable income and therefore increase demand.
      - However, can be ineffective as it may not increase spending as people expect deflation to continue, hence wait to spend when the products they want are cheaper.
    - - Cutting direct tax on incomes and profits in order to increase disposable income and hence encourage spending. With higher demand, the firms will increase price and cause inflation
  - - - If the government announces that they are planning to keep the rate of inflation low stable, people are less likely to demand big wage increases each year. This will help reduce the rate at which cost rise as less people will buy goods and supply of goods are also less increasing. Therefore, will help to reduce pressure on firms to increase their prices.
    - - they can increase public sector support for training and retraining workers in new and more advanced skills to boost their mobility and productivity. This would work in a way where the supply of goods and services in an economy expands at the same rate as the demand. This would not need for the cost and price inflation to occur at the first place.
      - They can also cut taxes on profits to encourage entrepreneurs to start-up and invest in more firms. This would also boost the supply in the economy adjusting to the changing demand.
      - Financial support or tax incentives to encourage firms to invest more in the research and development of new, innovative and more efficient products, production processes and materials. This would also boost supply in the economy matching the expanding demand at the same speed.
      - Government can add measures to encourage more competition between firms to lower prices.
    - - Governments may also introduce direct controls on some prices and wages. Such as capping the rate at which public sector wages can increase each year below the rate of inflation or freezing them all together so they remain constant. They will reduce the real disposable incomes and spending power of public sector workers.
      - The government can also introduce measures such as capping the prices firms can charge in markets regulated by the government. These may include markets for essential goods and services.
      - Lastly, they may also introduce measures such as capping the rate at which regulated firms can increase their prices which will help the economy to reduce its price inflation.
    - - The government can tighten or contract fiscal policy by reducing public expenditures or raising taxes. This will help the total demand in the economy to decrease and therefore, inflation to keep at low rates.
      - The government can also tighten or contract the monetary policy by increasing the interest rates to reduce the borrowing in the country. Higher interest rates may also cause the foreign exchange rates to appreciate resulting in a reduction in the imported price of goods.