Difficulties of measuring inflation – CPI an RPI aim to give a representative picture of what is happening in the country, therefore resulting in a slightly inaccurate picture. – The price of goods and services change, often improving in quality meaning that the increase in cost is not actually to do with inflation. Measures of inflation tend to overstate inflation as they measure the price of a fixed basket of products, the weights do not take into account people’s ability to alter what they buy each year. ( for example , people tend to veer away from more expensive products to cheaper alternatives).
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The Causes of Inflation Inflation can arise from both the demand side and the supply side . Inflation can be put into two categories – demand-pull and cost-push inflation. demand-pull – increases in the price level caused by increases in aggregate demand – arises when AD increasing at a faster rate than AS, when the economy is near its roductive capacity, increases in AD are likely to push up the price level. cost-push – increases in the price level caused by increases in the costs of production – Arises when the price level is pushed up by increases in costs of production.
A common cause of cost-push inflation is a rise in wage rates above increases in costs of production. Another reason is a rise in raw materials cost. – It is the decrease in AS that causes the price level to rise and real GDP to fall. The Consequences of Inflation 1. Fall in value of money With the price level rising , each loin coin will buy less. The purchasing power of money falls. This obviously depends on whether one’s disposable income rises by more or less than inflation. 2. Menu Costs The needs for firms in general to alter their prices in, for instance, catalogues, newspaper advertisements and websites.
This can involve considerable time and effort and can increase labour costs. It can also be expensive to print and distribute new catalogues. 3. Shoeleather costs costs In terms 0T extra time ana e TTort
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Involved In reauclng money n0101ngs. Involved in reducing holdings of cash and money in current accounts and seeking the highest interest rate. Firms cannot afford for money to be lying around during periods of inflation as it will be losing value. They need to place it in financial institutions and have to search out the most rewarding rate of interest. 4.
Administrative costs Inflation can impose other administrative costs of firms, staff time may have to be devoted to adjusting accounts , assessing raw material costs, negotiating with unions about wage rises and estimating appropriate prices. 5. Inflationary Noise The distorting effect that inflation causes. It means that market prices do not signal the relative scarcity of products efficiently. With inflation, consumers will be uncertain whether the rise in price does actually reflect a relative price rise or whether it is Just in line with inflation. 6.
Random Redistribution of income The factor that determines the outcome for a household is the relationship between the change in its income and the price level. Inflation can cause some people to gain in a way and some people to lose that is not based on economic or social merit. For example , some workers with weak bargaining power may not receive wage rises. 7. Fiscal Drag People’s income being dragged into higher tax bands as a result of tax brackets not eing adjusted in line with inflation. Tax payers will end up paying a higher proportion of their income in tax and so experience a fall in disposable income.
The government sill receive more tax revenue. 8. Uncertainty Much uncertainty is created by inflation which is one of its greatest problems. If firms are uncertain about what their costs will be and what prices they will receive from selling their products, they may be reluctant to invest. Inflation also complicates household finical planning , making it difficult for people to decide how much to save and where to place their savings. 9. Inflation causing inflation The experience of inflation can lead to people to behave in a way which causes inflation to continue.See More on Inflation