GCE A-LEVEL & IBECONOMICS · Demand-Pull Inflation An increase in incomes in the economy will increase consumption and aggregate demand as people become richer. When AD increases,

InflationGCEA-LEVEL&IB ECONOMICS

LessonStructure

◦MeasuringInflation◦LimitationsofCPI◦CausesofInflation◦Growthinmoneysupply◦ Demand-pullinflation◦ Cost-pushinflation

InflationThinkaboutafavoriterestaurantyoutendtogotoovertheyears.

Howhavethepricesofthefoodtherechanged?

Whatotheritemsinyourdailyliveshaveseenpricerisesovertheyears?Discusswithyourneighbour andcomeupwith3thingsonyourminiwhiteboard.

Inflation

Whattypeofgoods/servicesactuallycontributedtoinflationconsistentlyovertheyears?

InflationWithinhousingandhouseholdservices,thelargestcontributionswerefromowneroccupiers’housingcosts(a0.19percentagepointcontributiontotheCPIH12-monthrate);andcounciltaxandrates(acontributionof0.12percentagepoints).Electricity,gasandotherfuelsandactualrentalsforhousingeachcontributed0.05percentagepoints.

Otherlargeupwardcontributionscamefromtransport,recreationandculture,andfromrestaurantsandhotels.FurtherreductionsinfuelpricescontinuedthedownwardtrendincontributionsfromtransportthatbeganinSeptember2018.Withinthesecategories,themostnotablecontributionswerefrompackageholidays,cateringservicesandtheoperationofpersonaltransportequipment.

BasketofGoodsOnewaytomeasureinflationisbyusingthe________________________(CPI).It’sthegraphyoujustsaw!

Theindextakesinabasketofgoodsan_________householdwouldbuy,andcalculatethepricedifferenceyearonyeartocaptureinflation.

Notethatthemeasureisweighted accordingtotheproportionsofeachproduct.Thismeansitaccountsforthequantityandvalueofgoodsaswell.E.g.ifanaveragehouseholdbuys10eggsfor$0.5each,itwillinclude$0.5x10=$5costofeggsinthegrocerycategory.

BasketofGoodsButhowdotheydeterminewhatisanaveragehousehold’sbasketofgoods?

Ahouseholdexpenditure__________iscompletedtodecideonthebasketofgoodsandattach__________basedontheproportionofgoodstheyspendtheirincomeson.

Curiousonwhatgoodsareincluded/removed?

https://webarchive.nationalarchives.gov.uk/20160109130531/http://www.ons.gov.uk/ons/infographics/basket-of-goods-2014/index.html

LimitationsofCPILookupsomelimitationsoftheConsumerPriceIndexandfillintheblanksbelow!

- __________________________arenotincludedintheCPI,butisincludedintheRPI(_______________________)

- Becauseitisbasedonspendingofanaveragehousehold,actualinflationmaynotapplytofamilieswithhigherorlower___________

- CPIdoesnotincludeimprovementsinthe__________ofgoodsandservicesovertime,despitetheirpricesmayhaveincreased

EquilibriumPriceLevelandOutput

RealGDP0

PriceLevel

AS

P

AD

Q

WouldanyoneliketoremindmeofhowtofindtheequilibriumpricelevelandrealGDPofaneconomy?

Whattypeofdiagramwillweuse?

WelcometotheGRAZEEconomy!

Letusassumethatthiseconomyonlyproduces3Grazemini-biteseachyear.Eachstudentisahouseholdhopingtobuythesemini-bites.Thebuyerwhopaysthehighestpricewillgetthemini-bite.Let’sstartbidding!

WelcometotheGRAZEEconomy!

Avg.priceofaGRAZEmini-biteYear1Year2 (GrowthinMoneySupply)

Inthesecondyear,thegovernmentdecidestoprintoutmorebanknotes.Asaresult,thisincreasesthemoneysupplycirculatingtheeconomy.Everyonegets$100more.Let’sbidagain– whatwillhappentothepriceofGRAZEmini-bites?

GrowthofMoneySupplyThemoneysupplyistheamountofmoneycirculatingtheeconomyinagivenperiodoftime.Itnormallyincludescash,bankdepositsetc.

Anincreaseinthe______________tendstoleadto__________.Thereareafewreasonswhythereisalargeramountofmoneycirculatingtheeconomysuchas:

- BankofEnglandprintingmorebanknotes

- Decreaseininterestrates

- Bankslendingmoremoneyviaquantitativeeasing

WelcometotheGRAZEEconomy!

Avg.priceofaGRAZEmini-biteYear1Year2 (GrowthinMoneySupply)Year3 (Increaseinconsumption)

Inthethirdyear,theeconomyisdoingwell.Householdhasrisingincomesandstarteddemandingmoregoodsandservices.Asaresult,mosthouseholdsarelookingtobuy2Grazemini-bites.Let’sbidagain– whatwillhappentothepriceofGRAZEmini-bites?

Demand-PullInflation

Anincreaseinincomesintheeconomywillincreaseconsumptionandaggregatedemandaspeoplebecomericher.

WhenADincreases,pricesofgoodsandserviceswillbecomemoreexpensiveaspeoplearewillingtopaymoreforit,despitethereisnotanincreaseinthenumberofgoods.Thisiswhatwecall______________________.

RealGDP0

PriceLevel

AS

P1P

Q1

AD

Q

AD1

Demand-PullInflationCanyouthinkoftwosituationswhentherewillbedemand-pullinflationapartfromanincreaseinincomes?Discusswithyourneighbour.

Hint:ThinkaboutwhenwillfactorsofADincrease.

WelcometotheGRAZEEconomy!

Avg.priceofaGRAZEmini-biteYear1Year2 (GrowthinMoneySupply)Year3 (Increaseinconsumption)Year4(Productioncostsincrease)

Intheforthyear,worldpriceofoatsincreasedsignificantly.Asaresult,costofproductionincreasedsignificantlyandGrazehasdecidedtochargeatleast$300foreachmini-biteandcanonlyproduce2.Whatwillhappentothefinalprice?Let’sbid.

Cost-PushInflation

Anincreaseincostsintheeconomywillincreasepriceofgoodsandservices.Notonlytherearelessgoods/servicesavailableintheeconomymakingthemmostcostly,butalsofirmsincreasetheirpricestoprotecttheirprofits.

Thisisknownas___________________

RealGDP0

PriceLevel

AS 1

P1P

AS

Q

AD

Q1

Cost-PushInflationCanyouthinkoftwosituationswhentherewillbecost-pushinflationapartfromanincreaseinthecostofrawmaterials?Discusswithyourneighbour.

Hint:ThinkaboutwhenwillASdecrease.