04.2 Deflation
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Transcript of 04.2 Deflation
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REVIEW OF HWK
BoP Q&A
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Balance of Payment Questions.
1. What is meant by (2 marks each = 6 in total)
A trade gap?
A current account deficit?
A current account surplus?
2. Explain why an economic boom may result in a current accountdeficit. (3 marks)
3. Explain why a recession may result in an improvement in thecurrent account position. (3 marks)
4. To what extent might a current account deficit have an effect on
Employment?
Inflation?
Growth?
4 marks each = 12 marks Total = 24 marks
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Balance of Payment Questions.
1. What is meant by (2 marks each = 6 in total)
A trade gap?
the difference in value over a period
of time of a country's imports and
exports
A current account deficit?
Where M>X
A current account surplus?
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Explain why an economic boom may result
in a current account deficit. (3 marks)
Boom = lots of employment, consumer confidence, businessprofits.
Confidence = C + I which can often lead to greater need for goodsbeyond domestic production, therefore greater iMports!
Also draw a boom macro diagram what happens to prices?
So domestic goods more expensive & so less competitive, thereforeless eXports!
Also exchange rates gets stronger so SPICED!
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Explain why a recession may result in an
improvement in the current account position.
(3 marks) Draw a recession diagram
Increasing unemployment
Lower prices
Fall in confidence (both consumer and producer)
So more eXports with weaker exchange rates and lowerprices makes us more competitive
There might be lower iMports as they become moreexpensive
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To what extent might a current account deficit have an
effect on employment? Inflation? Growth?
Where M > X
Fall in employment but why? Rise in inflation but why?
Fall in growth but why?
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Inflation & Deflation
Recap & move forward
http://news.bbc.co.uk/1/hi/uk/8010442.stm -
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Recap
What was the more recent FIVE causes
of UKs rise in inflation last month?
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Recap
What was the more recent FIVE causes
of UKs rise in inflation last month?
F= Fuel
I = Imports create higher costs
V = VAT
E= exchange rates
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Recap
In theory what are the 2 different types
of inflation?
Demand pull inflation
Cost push inflation
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Recap
Can you draw me a cost push inflation
diagram (show SR & LR AS)
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Draw an Classical AD/AS
diagramPrice Level
Real NationalOutput
Y1
LRAS
0
AD
SRAS1
SRAS2
Y2
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Deflation
Is it good or bad?
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Deflation
Deflation is a sustained fall in the general
price level
A sustained period of negative inflation
The internal value of money rises
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Deflation for some productsAnnual percentage change in the consumer price index for selected items
Price deflation in many markets for UK consumers
Source: Reuters EcoWin
Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct
01 02 03 04 05
1996=100
-16.0
-14.0
-12.0
-10.0
-8.0
-6.0
-4.0
-2.0
0.0
Audio-visual and photo equipment
Clothing and Footwear
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Annual Percentage Change
Consumer Price Inflation for Goods and Services
All items (CPI), Chg Y/YAll goods, Index [ar 12 months]
All services, Index [ar 12 months]
Source: Reuters EcoWin
00 01 02 03 04 05 06
Percent
-3
-2
-1
0
1
2
3
4
5
6
Goods and Services Together
Inflation in Services
Inflation in Goods
Describe the changes
in the data provided.
What effects do you
think this had on the
economy?
Whats the
trend?
Whats the
start &
end points?
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The diagrams
demand side cause of deflation
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Demand side causes of Deflation
A Large (adverse) Fall in AD
Exogenous shocks to the economy
A global recession leading to a fall in exports
and investment A rise in the exchange rate (leading to lower exports and
cheaper imports)
Declines in domestic and international asset prices
Deliberate attempts by macroeconomic policy toreduce AD through tightening of fiscal and/ormonetary policy
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Next lesson..
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Multi choice
Dont get excited there is NO
multi choice for paper 2
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Real incomes rise whenever
A nominal incomes rise.
B the price level rises by more thannominal incomes.
C nominal incomes rise by more than the
price level. D the rate of inflation slows down.
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Inflation article
Read
use highlighters to select key positive &negative issues
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Whats so BAD about inflation?
RPI is an aggregate figure what doesthis mean?
Why are interest rates on mortgages such
an important monetary tool to controlinflation?
What is the difference between nominal
and real prices? The article identifies 4 problems ofinflation. What are they?
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LR Cost push deflation
Price Level
Real NationalOutput
Y1
LRAS
0
AD
SRAS1
Y2
LRAS
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Supply side causes of deflation
An Increase in Long Run Aggregate Supply
The supply potential of the economy has been boostedby a series of beneficial shocks such as
Impact of rapid technological advances Reductions in the international prices of commodities and capital
goods
Higher productivity which drives down unit cost of production
Exploitation of economies of scale leading to lower LRAC Excess supply in some industries due to over-investment in new
capital machinery i.e. deflation results from a persistent demanddeficit over existing and potential productive capacity.
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Deflation good and bad points!
http://news.bbc.co.uk/1/hi/business/7956654.stmhttp://news.bbc.co.uk/1/hi/business/7960816.stmhttp://news.bbc.co.uk/1/hi/business/8057695.stm -
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Consequences of Deflation Holding back on spending: Consumers may opt to postpone demand if they expect prices to fall
further in the future
Debts increase: The real value of debt rises when the general pricelevel is falling and a higher real debt mountain can be a drag onconfidence Mortgage payers on fixed mortgage interest rates will see the real cost of
servicing their debt increase
The real cost of borrowing increases: Real interest rates will rise ifnominal rates of interest do not fall in line with prices
Lower profit margins: This can lead to higher unemployment asfirms seek to reduce their costs.
Confidence and saving: Falling asset prices such as price deflationin the housing market hit personal sector wealth and confidence
leading to further declines in AD. Higher savings can lead to theparadox of thrift
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Or.
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January 2006 - inflation
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The questions