Economic Prep Hanson

Causes of inflation
Inflation is the the increase in price of a basket of goods that is used to represent the whole economy. Inflation is a decline in the purchasing power of money.
There are two types of ways that can lead to a change in inflation:
1) Cost push inflation
Cost push inflation are when the cost of production of products /or process of a service increase. This directly reflects in the product or service price. The business can either absorb this cost (as seen with British Airways) or increase their prices (easyjet). These are normally from external sources e.g. raw material costs, imported commodities, and rises in price of oil.
Raw material costs normally increase due to inflation in another country or a fall in the value of the pound.
A decrease in the exchange rate leads to imports becoming more expensive, increasing the price of imported goods.
Increase in wages/price of labour, leads to decrease in productivity for the same wage. unit cost of production increases and business's to keep on making the same profit margin will put their prices up.
Increases in indirect tax on cigarettes for example and vat will lead to an increase in the price of the commodity. Business can pass this on to the customer or absorb it however will elastic demand of cigarettes , they will pass it on.
The concept of cost push inflation is shown below in the diagram. It shows an inward shift of the short run aggregate supply curve. this causes a contraction of output and an increase in general prices.
When unemployment is low then a lot of workers are in jobs, to retain and hire the skilled workers left they will have to put their pay up to attract them to their business, if they want to keep output high.





Demand Pull Inflation
This occurs when total demand for goods and services exceeds the level of total supply in the economy. This usually occurs as a result of extensive growth into aggregate demand. There is a long list of items that can affect the growth of aggregate demand including:
1)consumer spending
2)investment
3)government spending
4)high exports
5)lower imports
What usually happens is authorities let the money supply grow faster than the economies ability to supply goods and services.

If the value of the pound depreciates then import will be more expensive and exports will be cheaper. Foreign buyers will demand more UK products and at full employment the only way to combat high demand will be an increase in price. Also strong economies abroad would lead to UK exports having higher demand.
Reduction in taxes, direct/indirect, will lead to more disposable consumer income and consumer spending will increase. (which is a main factor in aggregate demand)
If interest rates are low then there will be increased borrowing and spending as there is less incentive to save, and less money to pay back on loans.
Consumer confidence can be boosted which leads to increased spending as they feel safe. If house prices increase then this will lead to an increase in equity on their mortgage and if released there is also more disposable income.





Asses the contribution of the monetary policy committee of the Bank Of England has made to the control of Inflation in the UK.

The Monetary Policy Committee (MPC) is a committee of 9 members, 5 from the Bank of England and 4 external.The MPC meets monthly for a two day meeting after the first Monday of each month. They asses economic conditions and alter the interest rates to reach the level of inflation deemed satisfactory, this is set at 2.0% based on the CPI. This is to ensure price stability in the economy. If inflation goes over of under by 1% the governor of the Bank must write a letter to the chancellor. The interest rate decision is announced on the second day of the meeting.
The Bank of england is the central Bank of the United Kingdom, the bank was founded in 1694. It stands as the centre of the UK's financial system. The Bank promotes and maintains monetary and financial stability. As well as providing banking services to its customers, the Bank of England manages the UK's foreign exchange and gold reserves. Each quarter, the Bank publishes its Inflation Report, which provides a detailed analysis of economic conditions and the prospects for economic growth and inflation agreed by the MPC.
The Bank controls its interest rate decisions through its financial market operations - it sets the interest rate at which the Bank lends to banks and other financial institutions.
Inflation is a general rise in price across the economy as a percentage of the CPI. It is also the depreciation of the currency as you can buy less for your money.
Interest rates have a direct impact on everybody's finances. They stipulate how much interest u have to pay back on mortgages, loans and credit card bills. The also stipulate how much money u can get back with saving money.
For example if consumer spending is high, and aggregate demand therfore is high. If there too much money chasing too few products then demand exceeds supply. Prices will therefore rise and this is inflation. To reduce high inflation the MPC set the interest rates high. Once they are set high then consumers have less disposable income to spend on goods and services and therefore spend less. They have more to pay back on their mortgage repayments and on loans and credit cards. If they spend less then aggregate demand falls back to the equilibrium and lower demand means lower prices.
However if aggregate demand is too low then there is very low demand and there is excess supply of goods. This can lead to higher unemployment, dumping, loss of profits of business's loss of income for the government. This can mean interest rates are too high, and therfore need to be lowered.
From D2 to AD1- increase interest rates, from D3 to AD1 decrease interest rates.