External Environment: Inflation

Last updated Jun 26, 2023 Edit

• Business

Inflation is a sustained increase in the average price level of an economy.

• the rate of inflation is measured by the annual percentage change in the level of prices as measured by the consumer price index
• a sustained fall in the general price level is called deflation—in this situation the rate of inflation becomes negative

• the consumer price index is the mean measure of inflation for the UK
• the government has set the Bank of England a target for inflation (using the CPI) of 2%
• the aim of this target is to achieve a sustained period of low and stable inflation
• low inflation is also known as price stability

• when there is excess demand

• when costs rise

Inflationary case study: https://www.bbc.co.uk/news/business-12196322

• Very fast growth of demand for credit/borrowing
• High levels of consumer spending

• A period when general price levels fall
• Normally associated with a significant reduction in economic activity (depression/slump)
• Can also occur if the economy is rapidly building its productive potential

• Consumers postpone spending if they believe prices will go lower
• The real value of debt increases and makes it harder to pay debt off
• Falling asset prices (such as housing)
• Business profit margins fall due to lower selling prices

Some inflation is good for business

• The price elasticity of demand is an important factor in how inflation will impact revenue
• If the product is price elastic, then revenue is likely to fall during inflation
• If the product is price inelastic, then revenue will not change much during inflation
• Price elasticity of demand refers to the responsiveness of demand to changes in price

• A rise in general inflation:
  • Sales revenue should rise
  • But workers are more likely to demand higher pay to compensate for consumer price inflation
  • Labour intensive industries at more risk
• Input cost inflation
  • Cost-push inflation will vary from industry to industry
  • Firms that need to buy significant commodity raw materials may find profit margins squeezed if they cannot pass on increased costs to customers

Business