Inflation• To understand what inflation is• To identify how inflation might affect businesses• To evaluate how businesses might respond to inflation

Starter: Find out how much the average salary was in 1980 and how much it is today?

Inflation

“a sustained increase in the average price level”

Wages:£6,000

Wages:£26,500

1980 2015

(focus on whole economy - not one particular industry – it’s possible for individual industry to experience decreasing prices when the economy is

experiencing overall inflation)

Inflation Target

As prices rise, the value of money falls – the same money can’t buy as much as it used to.

Gov’t has set a target of 2% - best for a stable economy

The Bank of England is charged with the responsibility of controlling inflation through changes in the interest rate.

Measuring Inflation

A basket of goods represents the average collection of goods bought by households.

The price of the overall basked is compared month to month.

The percentage change of the price of the basket = rate of inflation that month.

What is in the Basket of goods?

Next’s chief executive, Lord Wolfson, has said George Osborne’s new national living wage will cost the company £27m a year by the end of the decade and risks creating a potentially harmful inflationary loop.

Wolfson, a Conservative peer and friend of the chancellor, said Next would raise prices to offset the cost of implementing the higher pay rate, although the increase could be as little as 1%.Under the chancellor’s plans, the minimum wage for over-25s will increase from £6.50 an hour at present to £7.20 in April next year, before rising to at least £9 by 2020. Next’s pay rate for adult starters is £7.04.

Wolfson’s comments are the latest in a series from companies about the impact of the new higher pay rate. Whitbread, the owner of Costa Coffee and Premier Inn, has said it will look at “selective” price rises to offset the cost, and the recruiter Manpower said the new rate has sent shockwaves through the labour market.

Cost-Push Inflation• Firms respond to higher costs by increasing prices

Causes:

↑imported raw material costs

↑ labour costs

↑ indirect or direct taxes paid by firms

Demand-Pull Inflation• Significant demand from consumers leads

firms to put prices up because consumers are willing to pay more

Causes:↑ exports

↓ interest rates → ↑ consumer spending

↑ wealth effect from ↑ house prices or stock market boom

Inflation and businesses… A little case study.Cadbury Schweppes has reported a 7% growth in the value of confectionery sales over the past 3 months. The two main reasons are the huge success of its of its new chewing gum brand, Trident, and the higher prices for most products. These higher prices were necessary to cover higher raw material costs caused by world inflation and the depreciation of the £ sterling exchange rate.1. Would you classify Cadbury’s decision to raise prices as being led by

cost-push or demand-pull factors?2. What can you say about the price elasticity of demand for

Cadbury’s confectionery products from the information above?

• http://www.telegraph.co.uk/sponsored/business/sme-home/news/10841654/low-inflation-business.html

Effects of Inflation on Businesses• Increased costs – raw materials and other

factors of production (labour? land?)- changing prices all the time also costs money (menu costs)

• Uncertainty – difficult to plan, difficulty to invest- consumers also don’t respond well to uncertainty and may hang onto their money

http://www.telegraph.co.uk/sponsored/business/sme-home/news/10841654/low-inflation-business.html

Effects of Inflation on Businesses

• Borrowing costs may rise – MPC may raise interest rates to combat inflation

• Paying off previous debts may become easier as their nominal value looks smaller compared to current figures

• Wider price increases could include revenue

• As inflation rises, so do property prices and the price of stock. Thus balance sheets tend to look healthier as rising property and stock values boost reserves.

Effects of Inflation on Businesses

• Worker unrest – workers may feel uneasy about rising prices and demand higher wages – could lead to conflict between workers & mgm’t

• Loss of competitiveness – UK prices look higher and higher compared to international prices → ↓ exports

Business strategies…