Inflation Notes

INFLATION

USE P.E.E.L

Inflation-Increase in the general price level

Deflation-Decrease in the general price level

Disinflation-Decrease in the rate of inflation, i.e. price level increases but at a decreasing rate

Purchasing power-Amount of goods a set amount of money will buy.

Price rise in a particular market (Called an individual price rise)

• Price of single good/service increases
• Usually caused by either an increase in market demand (sum of all individual demand)/decrease in market supply (sum of all individual supply) which results in a shortage. As a result, price is bid up by consumers who don’t want to miss out
• Examples-Price of bananas increases, market demand for apples increases

Persistent rise in the price level

• Prices on average are increasing.
• Caused by an increase in aggregate demand (sum of all demand-C+I+G+(x-m)) or a decrease in aggregate supply (Sum of all supply)
• Results in a loss of purchasing control
• Examples-Increase in electricity prices, most shopping is more expensive, cost of living increases, $10 buys less than it did last year

A price rise in one particular market is called an individual price rise. This is usually caused by either an increase in market demand or a decrease in market supply which results in a shortage at the current price. As a result, the price is bid up by consumers who don’t want to miss out. A persistent rise in the price level is caused by an increase in aggregate demand or a decrease in aggregate supply. This results in a loss of our purchasing power.

Sometimes increase in price of single good can cause all other prices to increase, e.g. petrol/electricity increase causes firm’s C.O.P to increase, so they raise their prices to maintain profit margins.

ISSUES OF INFLATION (price rise)

• Increases uncertainty for firms
• Household’s purchasing power falls        
• Wage/price spiral develops
• NZ exports become less competitive
• Firms cannot plan for future
• Speculative investment increases at cost of productive investment
• Money ceases to be stable in value
• Reduction of purchasing power, ability to buy goods and services decreases. Scarcity increases.
• Business confidence decreases due to uncertainty so production decreases and there is less growth and fewer jobs.
• Firms raise prices to anticipate inflation which may not actually occur.

AGGREGATE DEMAND/AGGREGATE SUPPLY MODEL

Macroeconomic model that explains the price level and real output through the relationship of AD and AS

Aggregate demand

• Total demand in economy (at a range of prices)
• Components of AD=C+I+G+(x-m)
• Individual demand (1 person), Market demand (1 good), Aggregate demand (All goods)

Aggregate supply-Total supply in economy (at a range of prices)

• Calculated by total supply of all firms (C.O.P)
• yF is when all resources are fully utilised (full capacity)
• Individual supply (1 business), Market supply (Business that supplies 1 good), Aggregate supply (All firms + all goods)

The AD/AS model explains the Price level and Real output through the relationship of AD and AS. AD is the total demand in an economy whereas AS is total supply in the economy. Changes in the price level are recorder on the vertical axis (this shows inflation) and changed in output are recorded on the horizontal axis (this shows economic growth. The yF line shows full employment.