Question

What is inflation?

2. How is inflation measured?

3. In your own words, what is demand-pull inflation?

4. In your own words, what is cost-push inflation?

5. How can excessive money in the economy cause inflation?

6. Who is especially hurt by inflation?

7. Who is hurt more by inflation, borrowers or creditors? Explain your response.

List five categories of goods and services included in the CPI.

9. What kind of goods are not included in the CPI?

Answer 1

1) Inflation is the overall rise in price of goods and services over a specific period of time.

2) Inflation can be calculated using CPI (basket of goods consumer consume) of current and the base year. Formula to calculate it: [(CPI of current year - CPI of base year) / CPI of base year] * 100

3) Demand pull inflation: It occurs when aggregate demand of a good rises abruptly while producers are not able to change their supply in that period of time. Consumers will be willing to pay more money for goods and services as there would be shortage when supply is not increased. The willingness to pay more would raise the price in the market and becomes a reason of inflation.

4) Cost push inflation:It occurs when there is rise in price of inputs / raw material used by producers which will reduce the profit of producer who will raise price to cover their loss which will result in inflation in economy.

5) Excessive money supply give more money in the hands of people which raises their willingness to pay for goods. Consumers tends to pay more for the same good when they have more cash in hand which becomes a reason of inflation.

6) People who keep cash in hands will realize the decline in real power of money. They will be able to buy less of the goods when inflation occurs.

7) Creditors always suffer more by inflation while borrower benefit from it. Assume creditor have lent money on 5% interest rate while inflation rate is 8%. There is 3% decline in real money of creditor after one year.

8) Main categories which are included in CPI are housing, education, transportation, clothing etc.

9) Food and energy is being excluded by CPI due to their volatility observed in the past. Their prices used to change very fast which inflate CPI unnecessarily