Inflation Is the Sustained Rise of the Average Price Level, the Bank of England Sets a Target for Inflation of 2%

Inflation is the sustained rise of the average price level, the Bank of England sets a target for inflation of 2% (+/- 1%).

When inflation is low and stable there are many benefits for the UK economy. For example business and consumer confidence will be high, this is because it is easier for them to predict what will happen in the economy in the future. This encourages businesses to invest as the economic outlook is positive and there is potential for growth and thus a potential to gain more profits. As investment is a component of AD the AD curve will push outwards and as long as supply can cope with the higher demand (which it should if investment rises) then the real output of the economy will increase. Consumers, when faced with inflation may bring purchases forward as it appears cheaper to buy products now, this leads to consumption (another component of AD) to rise and thus pushing out the AD curve and further increasing potential real output.

The price of oil and gas will become relatively cheaper with low and stable inflation because the pound should become stronger making imports seem cheaper. As the UK is a net importer of oil and gas the costs of production should fall, as production costs are a determinant of supply the supply curve should push outwards meaning the real output of a country should increase, ceteris paribus. Cheaper production costs should also mean lower prices for consumers, as savings are theoretically passed on, this should lead to an extension in demand, again giving rise to an opportunity to increase real output.

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