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Hugo Flower

on 26 September 2016

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Transcript of Inflation

Why is inflation bad?
= a sustained rise in the general price level
October 2013
The change in the price of 'stuff'
It is measured using an INDEX such as the CPI or RPI
A consumption survey is conducted to see what people buy most, then a price survey is done to see how much these goods cost
A basket of 650 goods is selected and their changes in price are measured
Those products that are bought more often are given a greater WEIGHT
It is an INDEX, so on the first year (the BASE YEAR), each good's price was given a value of 100
Every time inflation is measured (quarterly), prices are compared to the base year using percentages
eg. If prices in the second quarter of 2001 were 25% more than they were in the BASE YEAR, then the CPI would be 125.
The base year for the CPI is 2005
CPI does not include housing costs (council tax, mortgage repayments etc
Criticisms of the CPI:
CPI tends to be a smaller figure, so pensioners who have pensions linked to inflation will be worse off
CPI is used more widely across the world
Not everyone responds to the survey
Tastes and fashions change so the basket has to be changed
Can be manipulated to make inflation look lower
RPI uses arithmetic mean, while CPI uses geometric mean (therefore smaller)
CPI excludes the highest and lowest income households - less inclusive
The quality of a good may change, skewing the results
The exclusion of housing is debatable...
Costs of Inflation

Low inflation is the main macro economic goal for most western countries. This is because there are many economic costs of high inflation.
The Bank of England's inflation target:
Costs of Inflation Include:
•International competitiveness:
A relatively higher inflation rate will make British goods less competitive, leading to a fall in exports. However this may be offset by a decline in the exchange rate. But, if a country is in the Euro (e.g. Greece, Ireland and Spain) they can't devalue. Therefore, high inflation can be very damaging as it leads to a decline in competitiveness.
•Confusion and Uncertainty:
When inflation is high people are uncertain what to spend their money on. Also, when inflation is high firms may be less willing to invest because they are uncertain about future profits and costs. This uncertainty and confusion can lead to lower rates of economic growth over the long term.
•Menu Costs.
This is the cost of changing price lists. When inflation is high, prices need changing frequently which incurs a cost. However, modern technology has helped to reduce this cost.
•Shoe leather costs.
To save on losing interest in a bank people will hold less cash and make more trips to the bank.
•Income redistribution.
Inflation will typically make borrowers better off and lenders worse off. Inflation reduces the value of savings, especially if the saving is not index linked. However it does depends on the real rate of interest. e.g. if a saver gets a higher rate of interest than the inflation rate he will not lose out.
•Boom and Bust Economic Cycles.
High inflationary growth is unsustainable and is usually followed by a recession. By keeping inflation low it enables a long period of economic growth. E.g. in the UK, low inflation helped economic growth to be more stable in the period 1992-2007. Sustainable, low inflationary, economic growth is highly desirable.
Homework: In groups, make a presentation on UK inflation and how the costs affect people
In this lesson we will:

1. Understand the concept of inflation

2. Evaluate measurs of inflation

3. Evaluate the causes and costs of inflation
A fall in the general price level
A fall in the rate of inflation
Causes of Inflation:
Growth in the Money Supply
Full transcript