Notes on JC2 H1 Economics Lecture: Price Stability

Overview

• Focus on Price Stability as a macroeconomic goal.
• Discuss different types of inflation (Demand-pull, Cost-push) and deflation.
• Examine consequences for economic agents (consumers, producers, government).
• Explore macroeconomic policies to achieve price stability in both inflationary and deflationary contexts.

Important Concepts

• Demand-pull Inflation: Caused by rising Aggregate Demand (AD) nearing full employment.
• Cost-push Inflation: Caused by increased production costs, independent of AD.
• Deflation: Sustained decrease in the general price level.
• Consumer Price Index (CPI): Measures average price changes in a basket of goods/services.

Key Questions

1. How is inflation measured?
2. Types and causes of inflation.
3. Impact of inflation on economic agents.
4. Effectiveness of policies on different types of inflation.
5. Challenges of deflation and policy solutions.

Inflation Basics

Definition

• Inflation: Sustained increase in general price level over time.
• Degrees of Inflation:
  • Mild
  • Creeping
  • Galloping/Runaway
  • Stagflation

Inflation & Value of Money

• Inflation reduces purchasing power if income doesn't keep pace with price increases.
• Core Inflation: Excludes volatile items (e.g., energy, food).

Types and Causes of Inflation

Demand-pull Inflation

• Caused by a rise in AD due to increases in C, I, G, or (X-M).
• Multiplier Process: Initial AD increase leads to further rises in AD and income.

Cost-push Inflation

• Caused by increased costs (e.g., wages, raw materials).
• Often overlaps with demand-pull; difficult to separate.

Interaction

• Wage-Price Spiral: Wages and prices chase each other, worsening inflation.

Consequences of Inflation

Consumers

• Loss of purchasing power.
• Reduced value of savings.

Producers

• Investment uncertainty.
• Increased production inefficiencies.

Governments

• Impacts on economic growth, unemployment, and other macroeconomic objectives.

Macroeconomic Policies

Demand-side Policies

• Contractionary Fiscal Policy: Reduce AD via decreased government spending/increased taxes.
• Contractionary Monetary Policy: Raise interest rates to decrease AD.
• Limitations include time lags, expectation effects, and potential conflicts with other objectives.

Supply-side Policies

• Aim to increase SRAS/LRAS via market-oriented or interventionist approaches.
• Challenges: time lags, high costs, and potential resistance from interest groups.

Deflation

Causes

• Decreased AD or increased AS/LRAS.

Consequences

• Potentially reduces consumption and investment if due to decreased AD.
• Can increase real income and competitiveness if due to increased AS.

Policies to Combat Deflation

Expansionary Policies

• Fiscal: Increase government spending/lower taxes.
• Monetary: Lower interest rates, currency depreciation to boost AD.

Inflation vs. Deflation

• Price Stability: Ideal for economic growth and maintaining standard of living.
• Inflation: Can reduce spending power; moderate inflation can promote growth.
• Deflation: Short-term benefits offset by long-term economic downturns and high unemployment.

Conclusion

• Price stability is crucial for economic stability and growth.
• Effective policy implementation requires understanding the specific causes and types of inflation and deflation.