Inflation and purchasing power

Explain what inflation is and how it differs from a price increase in a single product: inflation is a general and sustained rise in almost all prices. Give two examples of each case (petrol prices rising due to a fault at a refinery; bread, bus fares, cinema tickets, and clothes all rising at the same time).

Not all prices rise at once or for everyone: one year oil and electricity rise by $15\ \%$ while mobile phones fall.

1. a) Explain why the 'official' inflation (the average) may not match the one your family suffers: it depends on what you spend on.
2. b) Think of a family that heats the house with diesel and another with solar panels: who feels that inflation more? What does this teach us when reading the CPI news?

The CPI is calculated by tracking the "shopping basket" of a typical family: the prices of hundreds of products are recorded every month.

1. a) Explain how this basket allows us to measure inflation.
2. b) Reason why the inflation felt by your grandmother (medicines, doctors, electricity) might be different from yours (leisure, technology, clothes).

Besides the general CPI, core inflation is also published, which removes energy and fresh food because their prices rise and fall so much (storms, harvests, wars).

1. a) Explain what the core figure shows (the underlying trend of prices).
2. b) If the general CPI reads $5\ \%$ because of electricity and the core one $2\ \%$, explain what is really happening with most prices.

The CPI basket weights each group according to its share of spending: housing and utilities $33\ \%$, food $25\ \%$, transport $15\ \%$, leisure $10\ \%$ and the rest $17\ \%$. This year these rise: housing $6\ \%$, food $4\ \%$, transport $2\ \%$, leisure $1\ \%$ and the rest $3\ \%$.

1. a) Calculate the weighted average inflation (multiply each rise by its weight and add up).
2. b) Explain why housing 'rules' so much in the CPI even though you don't pay it every week like the food shopping.

A sandwich cost $5\ \text{€}$ a year ago and inflation has been $5\ \%$.

1. a) Calculate how much it costs today if it has increased at the average rate.
2. b) Your weekly pocket money is still $20\ \text{€}$: calculate how many sandwiches you could buy a year ago and how many now.
3. c) Use this result to explain what losing purchasing power means, even though "your pocket money hasn't gone down".

Iris's mother's salary was $1.500\ \text{€}$ per month. This year she received a $2\ \%$ pay rise, but inflation was $4\ \%$.

1. a) Calculate her new salary.
2. b) Calculate the salary she would need to maintain her purchasing power exactly (so she can afford the same as before) and how many euros short she is.
3. c) Has she gained or lost purchasing power? Explain the difference between getting a pay rise and the cost of living going up.

The supermarket workers' collective agreement raises wages by $3\ \%$ and the year's inflation has been $5\ \%$. The average wage was $1.400\ \text{€}$.

1. a) Calculate the new wage.
2. b) Calculate what wage would be needed to avoid losing purchasing power and how many euros a month are lost.
3. c) Explain what the real wage is (the wage after discounting inflation) and why trade unions ask for CPI-linked review clauses.

Analyze the following two financial press headlines:

• Headline A: "The rise in the international price of natural gas and maritime shipping rates pushes up manufacturing costs for European industry."

• Headline B: "The extraordinary increase in direct aid and accumulated savings triggers a surge in travel and dining bookings, allowing hotels and restaurants to raise prices in the face of an avalanche of customers."

1. a) Classify each case with reasoned arguments according to the type of inflation (demand-pull or cost-push) and describe the mechanism through which prices end up rising in each headline.
2. b) Predict the effects of an aggressive interest rate hike by the European Central Bank if applied against the situation in Headline A: will it succeed in making imported gas cheaper? What impact will it have on economic activity and business employment? Justify why in this case the central bank faces a dilemma.

Spain imports the vast majority of the hydrocarbons it consumes. In an international context of war tensions, the price of a barrel of oil rises by $60\ \%$.

1. a) Describe the transmission chain that turns this external rise in crude oil into a widespread price increase in everyday consumer goods, such as vegetables or household cleaning products, justifying the concept of "imported inflation."
2. b) Critically evaluate why an interest rate hike by the central bank has very limited effectiveness in directly stopping this type of inflation, and what secondary economic costs it imposes on mortgaged households and businesses applying for loans.
3. c) Design two economic policy measures that a Government can adopt to cushion this impact: a short-term one aimed at the most vulnerable households, and a structural long-term one to reduce external dependence.

In an economy with an annual inflation rate of $7\ \%$, the works councils of the main productive sectors demand wage increases of at least $7\ \%$ to avoid losing purchasing power. At the same time, employers' organizations announce that if they take on this additional wage cost, they will increase the selling prices of their products by an equivalent percentage.

1. a) Draw up a cause-and-effect diagram demonstrating how this interaction triggers the so-called "wage-price spiral" (second-round effects), and explain why the initial inflation risks becoming chronic.
2. b) Predict how this spiral would affect the international competitiveness of the country's companies compared to competitors from other countries that keep their inflation under control.
3. c) Outline the basic framework of an "incomes pact" between employers, trade unions, and the Government: what reciprocal commitments or sacrifices should workers and business owners take on to curb the spiral by consensus?

Hyperinflation is runaway inflation, with prices rising every week or every day, like Germany's in $1923$ or Venezuela's a few years ago.

1. a) Explain what happens to money in that case (it stops being useful: people get rid of it as soon as they receive it and go back to barter).
2. b) Argue why households and firms can't plan anything with hyperinflation and why keeping inflation low and stable is a goal of the authorities.

Deflation is a general fall in prices, and it is also a concern. Explain the chain of events: if people expect everything to be cheaper next month, they delay purchases; shops sell less; businesses make less profit and lay off workers; with higher unemployment, even less is bought. Illustrate this using a fictional local furniture shop in your neighbourhood.

In a televised debate, a panelist argues: "The European Central Bank's goal of maintaining inflation around $2\ \%$ is detrimental to citizens; the ideal situation would be a continuous annual deflation of $2\ \%$, because that way money would be worth more each year and we would be richer."

1. a) Rebut the panelist's position by explaining the mechanism of the deflationary spiral: predict what would happen to households' consumption decisions and businesses' investment and hiring decisions if they knew for certain that prices will be lower next year.
2. b) Justify why central banks consider that moderate and predictable inflation (around $2\ \%$) is a sign of a healthy economy, distinguishing it from both deflation and runaway inflation.