Chapter 8: Macroeconomic Problems - Inflation
Deflation
Misc.
Causes of inflation
How to control inflation
Effects of inflation on:
Inflation: sustained increase in GPL of economy
Deflation: sustained decrease in GPL of economy
Note: GPL is for all items, not just select few
Disinflation: GPL increasing at a decreasing rate. (in graphs for inflation, see if it is increasing at decreasing rate and where 0 mark is on % axis)
Cost-push inflation (Change in AS)
Demand-pull inflation (Change in AD)
Measured by
Consumer-Price Index (CPI): avg price of a fixed basket of goods and services over time
Producer Price Index (PPI): index of wholesale prices, to measure price @ point of first sale.
GDP Inflator: measures changes in economy's price level. (ratio of nominal to real GDP)
Consumer: increasing due to consumer optimism. Less optimistic about the future, will spend more now and save less. Expected income to rise -> increase in C
Investment: opening of new export markets/tech innovations. Must invest in plant and equipment/build up stocks -> I increase
Government: increase in national defence exp, increase in social needs (education/healthcare for aging)
Exports and Imports: increasing national income of trading partners. higher purchasing power, more exports traded out
As AD increases, and approaches full employment level Yf, GPL will increase as output cannot be increased to meet higher demand. At Yf, additional spending is purely inflationary.
Change in SRAS (keynesian range ^)
Change in LRAS: QQT (classical range <)
Import price push: import of basic needs (small country). Increase in imported inputs cost causes SRAS to fall
Increased structural rigidity: lack of flexibility e.g min wage legislatively raised. COP increases, decreased ability to supply, decreased SRAS, increased GPL
Wage push: workers demand higher wages > firms accede > higher wages, increased COP > decreased SRAS > higher cost of living > further price increases, GPL spirals upwards
Currency depreciation: imported raw materials are more expensive, higher COP
e.g crude oil supply decreases > shortage > price of oil increases > increased COP
Severe loss/damage of productive resources: total FOP available drastically reduced, lowered productive capacity. LRAS shifts leftwards.
Profit push: monopoly power of firms cause them to have generally higher prices, thus increasing prices add to COP, SRAS falls
If anticipated, effects will not be as drastic (ref. deflation)
Investment: fall in I causes decreased AD, lower output and employment in economy.
Stagflation: cost-push inflation, recession (high unemployment, high inflation, low EG)
External stability: BOT (for one inflation and one w/o), X will not be equal to M (BOT deficit/surplus, ch10)
Resource allocation: distortions in relative price, misallocation of resources, alloctive inefficiency. (speculative buying in fear of high and rising inflation)
SOL: decreased PP, less ability to purchase g&s -> material SOL decrease. Ppl also have to work longer hours, less leisure time -> decrease in nm SOL.
Menu cost: constantly revising price lists (price of reprinting prices, menu, catalogues)
Shoe-leather cost: time and effort taken to counteract inflation. Intense search for financial assets offering high interest rate. Frequent trips wears down shoes -> shoe leather cost
Redistributive effects
savers lose, PP deteriorates
debtors benefit, creditors lose. inflation doubles, half the PP left for creditors when money is returned.
flexible income receivers: depends if GPD skips ahead of income.
lower price of g&s -> P anticipated to fall -> consumer delay consumption of big ticket items -> firms decreased DD due to decreased profit & decreased C ->decrease in AD -> deflationary spiral
Effects
Economy: BOT increases, price competitiveness increases as X increases when PED>1
Producers: decreased profitability, depressed demand
Consumers: redistribution of income from debtors and collectors
reduce DPI by reducing components of AD (C,I,G,X)
reduce CPI by improving productive processes