To what extent is inflation damaging to the economy? 18

Inflation is a sustained rise in the average price level. Inflation is measured in two ways the CPI and the RPI. CPI is a measure of the price level used across the European Union and used by the bank of England for setting its inflation target which is currently at 2%, it is calculated using a weighed basket of goods. This basket contains 650 goods. 100,000 households buying patterns of the goods in the baskets are recorded and the inflation rate is calculated through these figures. Maintaining a stable and anticipated inflation rate is a key government objective as it allows them to plan government spending for the future. There are two main theories for why inflation occurs demand pull and cost push. Demand pull inflation arises from aggregate demand shifting at a faster rate than aggregate supply. When the economy is working at near to its productive capacity, an increase in any components of aggregate demand are likely to cause a rise in price level as seen below. In contrast cost push inflation arises when the price level is pushed up by increases in the cost of production. A common cause of this is a faster rise in wages and a rise in the cost of raw materials eg a rise in the cost of oil will cause fuel costs to rise therefore increasing the costs of distributing goods in turn increases the cost of many household products.

There are many costs associated with inflation some problems are larger than others, a relatively small cost is that of ‘menu costs’ this is the cost of changing your prices eg new labels/price tags. This is more of a problem for small businesses as large companies such as supermarket chains constantly change their prices with special offers and such on a regular basis, they have sophisticated technology to do so inflation does little to affect this and could even raise