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TSR Wiki > Study Help > Subjects and Revision > Revision Notes > Economics > Inflation
Measurement and Definition
Inflation is a general rise in the price level.
Causes of Inflation
Rise in Costs
- Demand Pull
- Cost Push
- Wages due to union pay rise
Excess supply of Money
- MV PT
- M Supply of Money
- V Velocity of Money
- P Average price of transaction
- T Average number of transactions
- V and T are fixed therefore a rise in M will cause an increase in M
Costs of Inflation
- Loss of international competitiveness
- Inflation depreciation spiral
- Loss of information, as firms are unable to discern rise in demand from inflation
- Loss of savings, financial collapse
- Menu costs
- Redistribution
- Uncertainty and lack of investment
- Balance of payments
- Income and Substitution Effects
Measures to deal with Inflation
Savings and Inflation
Most studies found a positive correlation between savings and inflation. However, there are differing explanations:
- Deaton (1977): suggests that it is unanticipated inflation that matters. Consumers initially underestimate the average price level, and shocked by the "excessive" rise in prices cut their consumption in response until they recognise the higher price levels.
- Buckley (1981): suggests that even if inflation fully anticipated, the savings ratio will increase as long as anticipated inflation is itself increasing.
- Cuthbertson (1982): suggests that, due to inflation, the real rate of interest (nominal – inflation) often zero or negative, so real purchasing power of a given stock of liquid assets (notes/coins/bank deposits & other short-term assets) falls. Consumers, seeking to maintain the real value of their liquid assets for reasons of security or flexibility, thus have to reduce consumption of current real disposable income/increase saving to do so.
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