Theme 2

Question 1

What must you remember when talking about calculating inflation using CPI?

Answer 1

when talking about calculating inflation using CPI REMEMBER to use word ‘basket’ of goods and services used by average household (which is representative of all consumers)

Question 2

What factors factors can be responsible for a decrease in inflation (disinflation)?

Answer 2

• falling oil prices (see below)/falling commodity prices (same thing as oil- see below)
• changing relative exchange rates (appreciation-> imports cheaper … firms production costs who import raw materials fall-> lower domestic goods and services prices)
• government fiscal tightening (more taxation than GS-> firms and consumers having less disposable income-> less consumption by consumers and investment by firms-> decrease in 2 components of AD … less AD = less inflation)
• low consumer or business confidence (again business and consumers spend less on goods and services and less investment into R and D, capital equipment e.g for firms-> less AD and … less inflation)
• increase in savings (more savings means less spending and consumption … lower AD and less inflation)

Question 3

What is important to remember about inflation related questions?

Answer 3

(KEY- WITH INFLATION THINK OF FACTORS WHICH AFFECT EITHER DEMAMD OF PRODUCTION COSTS- demand pull or cost push inflation)

Question 4

How can falling oil/commodity prices lead to decrease in inflation?

Answer 4

LEARN- Falling oil prices in the world economy reduce key costs of production such as transportation, reducing prices of many products in the economy

Question 5

How can you evaluate a point about oil prices?

Answer 5

LEARN- oil prices are very volatile and could easily rise rapidly due to world events such as instability in the Middle East

Question 6

When talking about fiscal, monetary or supply side policy, what is a good good evaluation point?

Answer 6

EXTENT OF THE POLICY- e.g. amount of spending/taxation/investment in education/decrease or increase in interest rate/size of QE programme etc

Question 7

Why is QE effective?

Answer 7

• QE definition- purchase of gilts (bonds) & other illiquid assets to make credit easier to access (increase liquidity/money supply)
• should encourage banks to increase lending and thus hopefully increase consumption/investment- … benefits both consumers and businesses-> more AD (draw diagram showing rightward shift)
• Inflation/GDP may well have been much lower without QE (AD=GDP which increase with QE- ALSO rightward shit causes increases in price which is demand pull inflation)
• Confidence of markets would have been much lower without QE
• QE programme to be extended for a further 6 months- suggests that not that effective initially- potentially better alternatives
• Lower interest rates encourages consumption/investment, thus increasing AD and therefore inflation- NOTE WITH QE, INTEREST RATES BEING DECREASED AT THE SAME TIME- USED ALONGSIDE

Question 8

How would you evaluate QE?

Answer 8

• Nature of baking sector- not willing to lend despite more asset holdings
• Long term inflation
• Time lag
• Lack of confidence among firms and consumers meaning they are not responding as the government/central bank would like to the QE programme
• Other policies may be more effective- e.g. supply side policies to stimulate growth and inflation

Question 9

What are the consequences of a fall in oil prices?

Answer 9

• REMEMBER- oil has a macroeconomic consequence through the effect on the net trade (imports and exports) component of AD and/or shifting the costs of production for all firms as SRAS or LRAS shift (draw diagram showing AD shift as a result)
• An increase in overall economic activity (real GDP) as the cost of production decreases for businesses, especially for those that are heavily dependent on oil inputs
• Some sectors such as agriculture, air transport, services involving other travel and oil-intensive manufacturing sectors will benefit as the price of their key input falls
• Benefits for consumers- overall consumer prices fall as cost savings are passed on to households which spend more in domestic markets as a result hence increased consumer spending and AD, and real wages increase as demand for labour rises in fast-expanding sectors
• As a result of growing economic activity, government tax revenues may rise as the tax take from corporate and personal income taxes increase (increased fiscal dividend earned)

Question 10

How would you evaluate a fall in the price of oil?

Answer 10

• Problems for oil producers e.g Saudi Arabia and other Middle Eastern countries- profit maximisers … may reduce supply of oil and wait until prices increase- also might create scarcity
• Negative effect on consumer confidence, political instability with impact on markets
• Reduced research into new exploration of oil
• Reduced investment into new technologies to replace oil ($380 billion)
• Negative externalities may decrease (environmental degradation, global warming etc) e.g. fracking firms may be discouraged hence less supply
• Depends on how long the oil prices stays low, and how much further it will go
• Risks from ‘sectoral stagnation’ in developed economies or continued problems in the Eurozone e.g. the oil and gas extraction sector is negatively affected by the reduction in the oil price
• Government experiences declining tax revenues from the oil and gas sector