2.1.2 Causes of Inflation

Question 1

what are the three causes of inflation

Answer 1

• demand-pull
• cost-push
• growth of the money supply

Question 2

define demand pull inflation

Answer 2

a sustained rise in the general price level caused by excessive total demand in an economy for goods and services

Question 3

why does demand pull inflation occur

Answer 3

• there is too much money chasing too few goods and services
• when there is excess demand, producers will increase their prices to maximise profit margins

Question 4

which stage in the economic cycle is demand pull inflation usually associated with

Answer 4

boom

Question 5

how does reduced income tax and corporation tax cause demand pull inflation

Answer 5

cut in direct taxes, consumers have more disposable income so consumption increases.
firms have increased retained profit so investment increases
increase in consumption and investment increases AD

Question 6

how do lower interest rates cause demand pull inflation

Answer 6

lower cost of borrowing and reward for saving, so consumption and investment increase, increasing AD

Question 7

how does increased consumer spending cause demand pull inflation

Answer 7

maybe due to increased confidence or incomes
increase in consumption increases AD

Question 8

how does improved availability/affordability of credit cause demand pull inflation

Answer 8

borrowing is easier and cheaper, increase in consumption and investment increases AD

Question 9

how does a weak exchange rate cause demand pull inflation

Answer 9

weaker pound, imports more expensive as £1 can buy fewer units of foreign currency, exports cheaper as £1 cheaper for foreign consumers, increased net exports, increased AD

Question 10

how does fast growth in other countries cause demand pull inflation

Answer 10

increased GDP abroad, increased average incomes, increased demand for exports, increased net exports increases AD

Question 11

how does increased confidence and certainty cause demand pull inflation

Answer 11

increased consumption and investment, increase in AD

Question 12

how is demand pull inflation shown on a diagram

Answer 12

outward shift in AD

Question 13

define cost push inflation

Answer 13

a sustained rise in the general price level, caused by firms responding to rising costs of production by increasing prices of output

Question 14

why does cost push inflation occur

Answer 14

• firms increase prices to protect profit margins
• firms pass on high costs to consumers in the form of higher prices
• this will often cause a reduction in AS in the economy

Question 15

how do wage increases cause cost push inflation

Answer 15

increased cost of production, decrease in SRAS resulting in a higher GPL

Question 16

explain the wage price spiral

Answer 16

when GPL rises, real incomes fall, workers demand higher wages, wage costs for firms rise, increasing prices

Question 17

how do higher raw material costs cause cost push inflation

Answer 17

increase in cost of production (especially if resources are scarce in supply), decrease in SRAS resulting in higher GPL

Question 18

how do higher taxes cause cost push inflation

Answer 18

increase in indirect taxes e.g VAT on raw materials, leads to an increase in the cost of production, higher GPL as lower SRAS

Question 19

how do higher import prices cause cost push inflation

Answer 19

weaker pound, imports are more expensive as £1 buys fewer units of foreign currency, importers of raw materials and components have a higher cost of production, so higher GPL as lower ASRAS

Question 20

how do natural disasters cause cost push inflation

Answer 20

temporary or permanent decrease in supply of raw materials/components causes an increase in the cost of production, so higher GPL as lower SRAS

Question 21

how is cost push inflation shown on a diagram

Answer 21

shift SRAS inwards

Question 22

define shrinkflation

Answer 22

the practice of companies reducing the size or quantity of a product, while keeping the price the same or even raising it

Question 23

give some causes of the surge in UK inflation in 2022-23

Answer 23

• pandemic related supply shortages
• conflict in Ukraine
• labour shortages

Question 24

what is the money supply

Answer 24

a measure of the amount of stock on=f money in the economy

Question 25

what is narrow money (M0) and broad money (M4)

Answer 25

M0 - includes notes and coins in circulation
M4 - includes M0, bank deposits and other liquid assets

Question 26

how can the central bank increase the money supply

Answer 26

• printing more notes through the B of E
• use quantitative easing to create money electronically
• reduce deposit holdings of banks allowing them to lend more money
• the B of E can buy bonds off financial institutions creating liquidity

Question 27

how does a rising money supply cause inflation

Answer 27

greater supply of money, firms and consumers have more to spend, demand rises faster than supply creating excess demand, so firms increase prices to try and maximise profits

Question 28

give a country that has experienced regular price deflation

Answer 28

Japan

Question 29

what may cause deflation in an economy

Answer 29

demand side causes (inward shift of AD)
supply side causes (outward shift of SRAS)

Question 30

what could be a demand side cause of deflation

Answer 30

-deep fall in AD causing a recessions
- large negative output gap, high level of spare capacity

Question 31

what could be a supply side cause of deflation

Answer 31

• improved labour productivity
• technological advances
• significant fall in wage costs
• strong exchange rate causing import prices to fall

Question 32

which cause of deflation is less damaging and why

Answer 32

supply side - leads to actual growth

Question 33

which cause of inflation is considered less harmful and why

Answer 33

demand pull inflation is considered less harmful than cost push as it is associated with rising AD, actual growth and improved living standards

Question 34

which cause of inflation is considered more harmful and why

Answer 34

cost push - tends to be associated with falling output (known as stagflation)

Question 35

give another ev point for causes of inflation

Answer 35

businesses may choose to use increased profit margins to invest in new capital, increasing productive capacity in the future