Inflation and Price Stability

Question 1

state what is meant by inflation

Answer 1

the rate of change in the average price level overtime

• a general rise in prices
• a fall in the purchasing power of money

Question 2

state how the rate of inflation can be measured

Answer 2

can be measured using the Consumer Price Index

Question 3

explain the causes of inflation referring to cost-push inflation.

Answer 3

occurs when the firm responds to rising costs of production by increasing prices - firms typically do this to protect profit margins

higher taxes: the gov may impose higher taxes on firms for example national insurance
higher import prices: a weaker exchange rate mean that imported components feed through higher costs of production
natural disasters: may temporarily or permanently reduce the supply of raw materials adding to firms costs

Question 4

explain the causes of inflation referring to demand-pull

Answer 4

caused by excessive demand in the economy for goods and services - there is too much money chasing too few goods and services

lower interest rates: makes borrowing more attractive and saving less rewarding
general rise in consumer spending: higher incomes and consumer confidence
a weak exchange rate: will boost export growth

Question 5

explain the consequences of inflation

Answer 5

if wages and earnings remain constant, then as prices rise, consumers are worse off in real terms, as their disposable incomes will buy less goods and services than previously - inflation erodes the value of money

high inflation will lead to consumers purchasing goods and services today before prices rise further in the future.
firms will pass on costs to the consumer which will further fuel higher prices and increase inflation.

Question 6

explain the government policies to manage inflation (AD)

Answer 6

fiscal:

• reduced spending will lead to a fall in AD and vice versa
• increased taxes will lead to a fall in AD and vice versa

monetary policy:

• lower interest rates will see more borrowing, increasing AD
• higher interest rates will lead to less borrowing and an increase in saving, reducing AD

Question 7

explain the government policies to manage inflation (AS)

Answer 7

supply-side policy:

• increased spending on education and training will provide a skilled workforce, increasing the supply of suitable workers to the economy and thus lowering prices
• increased spending on infrastructure will make it easier and cheaper for firms to operate, leading to an increase in supply and therefore lowering prices.