A2 Economics
Mr. Miah
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Key word test: inflation, deflation, reflation
Changes in UK rate of inflation
Theories for the causes of inflation
Phillips curve analysis
Costs and benefits of inflation
L.O: Secure our understanding of key
inflationary terms.
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Inflation: a persistent or continuing rise in the
price level, or fall in the value of money.
Deflation: the opposite, persistent tendency for
the price level to fall; involving a rise in the value
of money.
Reflation: increase in economic activity and
output, reflationary policy stimulates AD.
What policies can be encouraged to boost reflation?
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ANS: increasing money supply, reducing taxes, lowering interest
rates.
What is CPI?
A measure that examines the weighted average of
prices of a basket of consumer goods and services,
such as transportation, food and medical care.
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The CPI is calculated by taking price changes for
each item in the predetermined basket of goods
and averaging them; the goods are weighted
according to their importance.
Changes in CPI are used to assess price changes
associated with the cost of living.
What is RPI?
One of the two main measures of consumer
inflation produced by the United Kingdom's Office
for National Statistics.
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The Retails Price Index (RPI) was introduced in the
U.K. in 1947, and was made official in 1956. Like
the Consumer Prices Index (CPI), the RPI tracks
changes in the cost of a fixed basket of goods over
time, and is produced by combining about
180,000 price quotes for over 650 representative
items.
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Both RPI and CPI measure inflation. Both of them do it by
taking a basket of goods – food, clothes, petrol - looking
at what they cost last year, looking at what they cost now,
and finding the proportional difference.
But the CPI leaves the costs of your home out of the basket
– so rises in mortgage payments, rents, and council tax,
which in real life you pay, don’t get reflected in it.
However, the RPI does take account of those costs.
There is a mathematical difference as well. The RPI
calculates its ‘proportional difference’ using the
arithmetical mean between the old price and the new, the
CPI uses the geometric mean. The end result is that the RPI
always gives a bigger figure for inflation than the CPI.
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what’s CPI and RPI?
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Until 2003, the UK government measured
changes of inflation with the Retail Price
Index (RPIX); this measures the underlying
rate of inflation.
BUT, now the government use Consumer
Prices Index (CPI).
CPI is defined as the UK price index most
central to UK monetary policy.
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Article from the BBC
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Highlight the key information
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Interpret the article:
◦ Current UK inflation position
◦ Movement of inflation
◦ Reasons to fluctuation in inflation rate
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Two main tasks are undertaken to construct
CPI and RPI:
◦ Sample of good
◦ Weighting goods in the sample
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ONS: ‘shopping basket’ theory for CPI and RPI
on page 252 and 253.
Discuss and identify the definitions of each
term using the ‘shopping basket’ theory.
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Changes in the National Shopping Basket
In pairs, discuss and answer the follow-up
question on page 253.
Think – Pair - Share
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Draw Table 17.1 – Theories on the
causes of inflation
Then comment on the development of
inflation from the 18th century to
modern times.
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Definition: a theory that assumes inflation is
caused by a prior increase in the money
supply.
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Oldest ‘theory’ of money and a demand-pull
theory.
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IMPORTANCE:
Presently, quantity theory of money occupies
a central place in context to inflation and
deflation.
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The theory (old or new) are both based on a
the demand-pull inflation.
In its simplest form, the quantity theory of
money is at times it is described as too much
money chasing too few goods.
Starting point to develop this theory is:
Money Supply × Velocity of circulation = Price level × Total transactions
MV = PT
This is known as the Fisher equation of exchange
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*Understand the difference between demandpull and cost-push inflation.
Video explanation
◦ Explain the difference between demand-pull and
cost-push inflation.
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Video: Depict AD/AS graphs to explain both
theories, using any relevant examples. This
will be marked.
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Necessary assumptions are needed:
Velocity of circulation OR speed at which
money is spent are both fixed or at least
stable.
Money is a medium of exchange, but not a
store of value – what does this mean?
Means people quickly spend any money they
receive.
Summary of Quantity Theory – pg. 255
Q. What are the Similarities and Differences between the
quantity theory of money and demand-pull theory of
inflation?
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Similarities: Both theories explain inflation in terms of
excessive demand; pulling-up average price level.
Differences: Key difference is the underlying cause of
excess demand:
- Monetarist believe government is responsible
- Keynesians see it as too much consumer spending
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Draw AD/AS diagram and explain using your
own words.
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Page 258: THINK-PAIR-SHARE
Draw the cost-push inflation figure 17.4 and
explain.
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You will produce a presentation answering
the following:
◦ Definition and purpose of the Phillips curve
◦ Its historical presence in the economy
◦ Explain the Phillips curve relationship
◦ Distinguish between short-run and long-run
Phillips curve
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Definition: the curve is based on evidence
from the economy that shows the relationship
between the rate of inflation and level of
unemployment.
There’s a direct relationship with inflation
and unemployment.
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RECAP
Video on the Phillips Curve
Q. According to the video, what are the two
main causes of inflation?
Q. Explain the relationship between inflation
and unemployment.
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Read page 260-261 and summarise what is
meant by:
◦ Expectations-augmented Phillips curve
◦ National rate of unemployment (NRU)
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Explain, in detail with the use of figure 17.7, the
concept of long-run and short-run Phillips curve.
*EXAM TIP: Must understand difference, and
relationship, between short-run and long-run
Phillips curves.
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Page 264-265
Figure 17.8:
 A good deflation diagram
 A bad deflation diagram
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Inflation psychology
Possible problem of price deflation
Costs and benefits of price deflation
*EXAM TIP: essay questions may ask for
explanation of the costs and benefits of
inflation, followed by assessment of whether
costs exceeds the benefits.
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**THIS FINISHES OFF CHAPTER 17**
January 2012
02 Extract B (line 10) suggests that ‘there is
often a trade-off’ between inflation and
economic growth.
Explain why there might be a trade-off
between inflation and economic growth and
analyse one cause of inflation. (10 marks)