Inflation Notes
INFLATIONUSE P.E.E.LInflation-Increase in the general price levelDeflation-Decrease in the general price levelDisinflation-Decrease in the rate of inflation, i.e. price level increases but at a decreasing ratePurchasing 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 increasesUsually 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 outExamples-Price of bananas increases, market demand for apples increasesPersistent rise in the price levelPrices 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 controlExamples-Increase in electricity prices, most shopping is more expensive, cost of living increases, $10 buys less than it did last yearA 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 firmsHousehold’s purchasing power falls        Wage/price spiral developsNZ exports become less competitiveFirms cannot plan for futureSpeculative investment increases at cost of productive investmentMoney ceases to be stable in valueReduction 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 MODELMacroeconomic model that explains the price level and real output through the relationship of AD and ASAggregate demandTotal 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.