Inflation

** Inflation is defined as a rise in the general level of prices over a period of time.

So Inflation is basically when goods in general become more expensive. This has a number of effects on the economy, some of  which are listed below.


Effects or Results of Inflation

• The Purchasing Power of money falls
• Wage-Price spiral    wages go up causes costs and prices to rise which causes wages to go up & so on.
• Loss of jobs             as cost of business increases. 
• Loss of National competitiveness
• Rise in Government spending, which can add further to inflation. as everything has increased in price, the Govt. must spend more to get the same amount of goods.
• Those on fixed incomes suffer
• Interest rates rise. to keep the real interest rate constant (interest rate - inflation = real interest rate)

What causes inflation?

There are three types of inflation that we must be aware of cost push inflation, demand pull and Government caused inflation. 

Cost Push Inflation

This is inflation caused by a shift in supply due to the rising costs of doing business, these could include the cost of labour - wages, capital costs such as rising land or building costs or a rise in the cost of primary products such as wheat, grain or petrol. 

Demand Pull Inflation 

This is a rise in the general level of prices caused by a shift in the demand for goods causing the equilibrium price to rise. This could be caused by an increase in the money supply, or an apparent shortage of a good compared to the demand causing the prices to be bid up.

Government Caused Inflation

This is inflation caused by direct action by the Government from raising indirect taxes, increasing Government spending (causing demand pull) or increasing the costs of doing business by increasing admin costs or rates (causing cost push).

How do we calculate Inflation?

In Ireland we use the Consumer Price Index to calculate the rate of inflation. The Government do a shop every three years of 1000's of items and work out how the overall price has changed, they then work out the inflation rate. Every three months we get figures which give us an indicator of the general level of prices have changed. 

Below is a composite price index of some goods I buy on a regular basis. Normally you will be given the price in years 1 and year 2 and the weight or percentage of your income you spend on each item. 

1.  You will have to calculate the percentage change in price, by dividing P2 by P1.
2. Then you should multiply the percentage change by the weight. 
3. Once you add up all of these you will get the price index for the current year. This shows the amount you spent this year as a percentage of last years total spend.
4. To get the inflation rate you take 100 from this number. 

Below is a graph of Ireland's rate of inflation from Jan 1995 to Today. You can see that the rate of inflation was steadily around 2% until 2001 where it jumped a little before leveling out again and it fell sharply in 2008 to a low of -6.6% in Dec '09.

The Graph below gives a more detailed monthly look at the rate of Inflation over the last couple of years.

Although inflation hasn't come up on the LC Higher level paper since 2008, it used to come up about every second year and could make a come back in 2013.

The type of question we have seen on inflation in the leaving cert tend to look for the consequences of or results of or effect of Inflation. This is just three ways of asking what happens in the economy when there is inflation.
Pupils can also be asked to complete a composite price index and calculate the change in prices between two years for a number of goods.