Study Notes
Inflation is the persistent increase in the general price level of goods and services in an economy over time, measured using the Consumer Price Index (CPI). It can be caused by demand-pull or cost-push factors.
- Inflation — persistent increase in the general price level over time. Example: A country experiences inflation if prices rise by 3% over a year.
- Deflation — persistent decrease in the general price level over time. Example: If prices fall by 2% over a year, the economy is in deflation.
- Disinflation — decrease in the rate of inflation. Example: Inflation rate drops from 5% to 3%.
- Consumer Price Index (CPI) — a weighted average price of a basket of goods and services used to measure inflation. Example: CPI increases from 100 to 108.5, indicating inflation.
- Demand-pull inflation — inflation caused by an increase in aggregate demand. Example: Increased consumer spending leads to higher prices.
- Cost-push inflation — inflation caused by a decrease in aggregate supply due to higher costs. Example: Rising wages increase production costs, leading to higher prices.
Exam Tips
Key Definitions to Remember
- Inflation
- Deflation
- Disinflation
- Consumer Price Index (CPI)
- Demand-pull inflation
- Cost-push inflation
Common Confusions
- Confusing disinflation with deflation
- Misunderstanding the construction of CPI
Typical Exam Questions
- What is inflation? Inflation is the persistent increase in the general price level of goods and services over time.
- How is the CPI constructed? The CPI is constructed by selecting a basket of goods and services, assigning weights, and calculating a weighted average price.
- What are the causes of demand-pull inflation? Demand-pull inflation is caused by an increase in aggregate demand components like consumer spending and investment.
What Examiners Usually Test
- Understanding of inflation and its measurement
- Ability to distinguish between inflation, deflation, and disinflation
- Knowledge of the causes and effects of inflation and deflation