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10.1 Interest and Inflation Rates:

Terms in this set (32)

What do interest rates tell us?
Interest rates tell us the cost of borrowing or the returns on savings
What is the interest for borrowing?
The interest rate for borrowing money is the money charged for doing so, it's calculated as a percentage of the amount borrowed. A fall in interest rates means a decrease in the cost of borrowing for businesses. A rise in interest rates leads to an increase in cost of borrowing.
What is the interest for saving?
The interest rate on savings is the amount of money paid into a savings account by the bank, based on how much the customer has saved in the account. A fall in interest rates leads to a decrease in return on savings and a rise in interest rates leads to a greater return.
Who sets England's base rate?
The Bank of England sets the base rate of interest. The base rate influences other banks interest rates, although banks can choose to set interest rates higher or lower than the base rate.
What effect will changes in interest have?
Changes in interest rates will affect a business's costs if it has a loan or a mortgage. Interest rates also affect consumer spending and therefore business.
How do interest rates affect consumer spending?
Interest rates affect consumer spending and therefore business. High interest rates mean most consumers have less money to spend, people with existing borrowing like mortgages have to pay more money as interest so they have less disposable income and the market demand goes down
What other effect does a high interest rate have?
With a high interest rate, people may also decide to save more to take advantage of the interest earned on their savings, reducing demand
What effect does low interest rates have?
Low interest rates mean consumers have more disposable income and there is less reward for savings, so demand goes up
Why does the effect of interest affect some businesses more than others?
The effect of interest rates on demand depends on the product. Products that often require borrowing such as cars and homes are more sensitive to interest rate changes. When interest rates go up significantly, firms can change strategy to diversify away from these products and go into cheaper ones.
What is inflation?
Inflation is the overall increase in the price of goods and services
What are the two types of inflation?
Cost-push inflation and demand-pull inflation
What is demand-pull inflation?
Demand-pull inflation is where there is too much demand (more than what the economy can supply). It happens when there is an overall increase of disposable income so people buy more and businesses can't supply the goods quick enough, so they increase prices to get rid of excess demand. Demand pull inflation can make profit margins go up since businesses cna put prices up in response to high demand without their costs going up too much.
What is cost-push inflation?
Cost-push inflation is where rising costs push up prices. Employees wage rises can make prices go up, especially if productivity isn't rising. Cost-push inflation can make profit margins go down if a business decides not to put up their prices.
What is the rate of inflation?
The rate of inflation is the percentage change in the price of goods and services within an economy, in one year compared to the previous year
What can make inflation worse?
Black swan events and expectations
Give an example.
A business which is expecting its supplier to increase its costs may increase its prices in preparation for the increased unit cost. The rising prices of goods may cause people to demand higher wages which in turn increases a businesses labour costs which may force the business to further increase its prices. Additionally, as disposable income increases, there's an increase in demand as people can afford more which causes prices to rise further.
What is this called?
This is called the wage price spiral and it is a big cause of cost push inflation
What happens temporarily when inflation is high?
When inflation is high, spending goes up temporarily as people rush to buy more before prices increase further. But if wages don't rise to match inflation, spending goes down as people can afford less.
Is inflation good or bad for UK trade?
When inflation is high in the UK, it makes
exports more expensive abroad and makes UK businesses less competitive globally. When inflation is low in the UK, it makes exports cheaper abroad and makes UK businesses more competitive globally.
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What is deflation?
Deflation is an overall decrease in the price of goods and services within an economy. Deflation is the opposite of inflation. There's not enough demand so businesses reduce their prices.
What does deflation cause a fall in?
Deflation causes a fall in productivity because businesses wont keep endlessly supplying a market with goods no one wants.
What is deflation linked with?
Deflation is linked with unemployment since lower productivity usually means firms don't need as many workers. This makes demand drop more and causes firms to drop further in price.
What can be used to track inflation?
The consumer prices index can be used to track inflation
What does the consumer price index track?
The consumer prices index can be used as a measure of inflation in a country, it uses index numbers to track the changes in the average cost of a basket of a hundred goods consumers would usually buy
How can a consumer price index graph be used?
A graph line going up between two consecutive years shows inflation whereas a graph going down between two consecutive years shows deflation.
How is the index number calculated?
Index number = average value of basket / base value of basket x 100
What businesses are especially affected by interest rates?
Businesses producing premium goods. Businesses producing premium goods are the most likely to be affected by inflation because if customers have less money to spend, they start to look at cheaper alternative products.
How may a business recover from high interest rates?
Manufacturers of premium products can react by reducing prices, but they must be careful not to reduce the prices to the point where it is no longer seen as a luxury product, or by heavily investing into advertising.
Why may it be a good time for a business to expand during times of high inflation?
Periods of high inflation can be a good time
for firms to expand, if interest rates are lower than the rate of inflation, it's cheaper for them to borrow money to invest in new machinery or premises rather than save since the amount they would earn from savings would be less than the amount prices has gone up by, so it makes sense to spend rather than save. However, the bank of England often raises its base rate in times of high inflation to encourage savings, so businesses don't always benefit off high interest rates.
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What may a business choose to do if interest rates are high in the country?
When the UK interest rate is high or fluctuating, firms tend to expand into countries with low stable interest rates as it's cheaper to borrow money for expansion there.
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