2RecapName ‘FIVE’ causes of UK’s rise in inflation.
3Recap F= Fuel I = Imports create higher costs V = VAT E= exchange rates
4Recap In theory – what are the 2 different types of inflation? Demand pull inflationCost push inflation
5RecapCan you draw me a demand pull inflation diagram (show SR & LR AS)
6DEMAND PULL INFLATIONSRAS2LRASPrice LevelSRASIn the LR, workers are not willing to sacrifice Leisure time for more overtime…. But still have high wage expectations….demand pull inflationAD1ADY1Y2Real National Output
7RecapCan you draw me a cost push inflation diagram (show SR & LR AS)
8Draw an Classical AD/AS diagram LRASSRAS2Price LevelSRAS1ADY2Y1Real National Output
12What’s the start & What’s the end points? trend? Describe the changes in the data provided.What effects do you think this had on the economy?
13– demand side cause of deflation The diagrams– demand side cause of deflation
14DEMAND PULL Deflation… LRASPrice LevelSRASADAD1Y2Y1Real National Output
15Demand side causes of Deflation A Large (adverse) Fall in ADExogenous shocks to the economyA global recession leading to a fall in exports and investmentA rise in the exchange rate (leading to lower exports and cheaper imports)Declines in domestic and international asset pricesDeliberate attempts by macroeconomic policy to reduce AD through tightening of fiscal and/or monetary policy
17Demand-pull inflation is most likely to be caused by MC practiceDemand-pull inflation is most likely to be caused byA total spending exceeding productive capacity.B an increase in output.C a rise in raw material prices.D a rise in interest rates.Mrs Gordon's notes
18An economy is most likely to be in the boom phase of the trade cycle when there is a rise in A business pessimism.B the savings ratio.C spare capacity.D the demand for imports.
19Real incomes rise whenever A nominal incomes rise.B the price level rises by more than nominal incomes.C nominal incomes rise by more than the price level.D the rate of inflation slows down.
20What’s so BAD about inflation? “RPI is an aggregate figure” – what does this mean?Why are interest rates on mortgages such an important monetary tool to control inflation?What is the difference between nominal and real prices?The identify 4 problems of inflation. What are they?
21– supply side cause of deflation The diagrams– supply side cause of deflation
22SR Cost ‘push’ deflation LRASPrice LevelSRAS1SRAS2ADY1Y2Real National Output
23LR Cost ‘push’ deflation LRASLRASPrice LevelSRAS1ADY1Y2Real National Output
24Supply side causes of deflation An Increase in Long Run Aggregate SupplyThe supply potential of the economy has been boosted by a series of beneficial shocks such asImpact of rapid technological advancesReductions in the international prices of commodities and capital goodsHigher productivity which drives down unit cost of productionExploitation of economies of scale leading to lower LRACExcess supply in some industries due to over-investment in new capital machinery i.e. deflation results from a persistent demand deficit over existing and potential productive capacity.
25Deflation – good and bad points! Impact on Households?Consumers?Employees?Businesses?
26Consequences of Deflation Holding back on spending:Consumers may opt to postpone demand if they expect prices to fall further in the futureDebts increase: The real value of debt rises when the general price level is falling and a higher real debt mountain can be a drag on confidenceMortgage payers on fixed mortgage interest rates will see the real cost of servicing their debt increaseThe real cost of borrowing increases: Real interest rates will rise if nominal rates of interest do not fall in line with pricesLower profit margins: This can lead to higher unemployment as firms seek to reduce their costs.Confidence and saving: Falling asset prices such as price deflation in the housing market hit personal sector wealth and confidence –leading to further declines in AD. Higher savings can lead to the paradox of thrift
29QUESTIONS Explain what is meant by the term “deflation”. With reference to Extract 1, explain the effect on GDP of the change in asset prices in 1990.Explain why “deflation needn’t be all bad”? (line 28, extract 2)With reference to the extracts, examine the problems associated with a long period of deflation.Assess the relative effectiveness of using monetary and fiscal policy to move the economy out of a period of deflation.How might the continuing deflation in Japan affect the global economy?