Inflation & Deflation Recap & move forward…

Recap Name ‘FIVE’ causes of UK’s rise in inflation.

Recap F= Fuel I = Imports create higher costs V = VAT E= exchange rates

Recap In theory – what are the 2 different types of inflation? Demand pull inflation Cost push inflation

Recap Can you draw me a demand pull inflation diagram (show SR & LR AS)

DEMAND PULL INFLATION SRAS2 LRAS Price Level SRAS In the LR, workers are not willing to sacrifice Leisure time for more overtime…. But still have high wage expectations…. demand pull inflation AD1 AD Y1 Y2 Real National Output

Recap Can you draw me a cost push inflation diagram (show SR & LR AS)

Draw an Classical AD/AS diagram LRAS SRAS2 Price Level SRAS1 AD Y2 Y1 Real National Output

Deflation Is it good or bad?

Deflation Deflation is a sustained fall in the general price level A sustained period of negative inflation The internal value of money rises

Deflation for some products

What’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?

– demand side cause of deflation The diagrams – demand side cause of deflation

DEMAND PULL Deflation… LRAS Price Level SRAS AD AD1 Y2 Y1 Real National Output

Demand side causes of Deflation A Large (adverse) Fall in AD Exogenous shocks to the economy A global recession leading to a fall in exports and investment A rise in the exchange rate (leading to lower exports and cheaper imports) Declines in domestic and international asset prices Deliberate attempts by macroeconomic policy to reduce AD through tightening of fiscal and/or monetary policy

Multi choice…

Demand-pull inflation is most likely to be caused by MC practice Demand-pull inflation is most likely to be caused by A 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

An 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.

Real 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.

What’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?

– supply side cause of deflation The diagrams – supply side cause of deflation

SR Cost ‘push’ deflation LRAS Price Level SRAS1 SRAS2 AD Y1 Y2 Real National Output

LR Cost ‘push’ deflation LRAS LRAS Price Level SRAS1 AD Y1 Y2 Real National Output

Supply side causes of deflation An Increase in Long Run Aggregate Supply The supply potential of the economy has been boosted by a series of beneficial shocks such as Impact of rapid technological advances Reductions in the international prices of commodities and capital goods Higher productivity which drives down unit cost of production Exploitation of economies of scale leading to lower LRAC Excess 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.

Deflation – good and bad points! Impact on Households? Consumers? Employees? Businesses?

Consequences of Deflation Holding back on spending: Consumers may opt to postpone demand if they expect prices to fall further in the future Debts 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 confidence Mortgage payers on fixed mortgage interest rates will see the real cost of servicing their debt increase The real cost of borrowing increases: Real interest rates will rise if nominal rates of interest do not fall in line with prices Lower 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

Past paper practice

QUESTIONS 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?