Inflation

Inflation

1. The Cost of Inflation

   • Shoe-Leather Costs
     • 'Shopping around'
   • Menu Costs
     • If there is inflation, restaurants have to change their menus to show increased prices. Similarly, to shops, ect
   • Psychological and Political Costs
     • People feel they are worse off, even if their incomes rise by more than the rate of inflation
   • Unemployment and Growth
     • Inflation increases costs of production and creates uncertainty
       • This lowers the profitability of investment and makes businessmen less willing to take the risks associated with any investment project
   • Re-distributional Costs
     • Inflation can redistribute income and wealth between households, firms and the state

2. The Causes of Inflation

   • Demand-Pull Inflation
     • If AD rises and there is no increase in AS. This could be caused by
       • Consumer spending may rise excessively
       • Firms may substantially increase their investment spending
       • World demand for UK exports may be rising because of a boom in the economy
       • The government may be increasing its spending, or cutting taxes
   • Cost-Push Inflation
     • Occurs because of rising costs
       • Imports can rise in price
       • Profits can be increased by firms when they raise price to improve profit margins
       • Wages/Salaries account for 70% of national income and hence increases in wages are normally the single most important cause of increasing in costs
       • Government can raise indirect tax rates or reduce subsidies thus increasing prices

3. Measuring Inflation

   • A Price Index only measures inflation for average households. It also cannot take into account changes in the quality and distribution of goods over time
   • In the UK there are 2 measures of the Price Level
     • Retail Price Index (RPI)
     • Consumer Price Index (CPI)

4. Inflation is defined as a sustained general rise in prices

   • Hyper-Inflation describes a situation where inflation levels are very high
   • Creeping inflation would describe a situation where prices rose a few % on average each year