4.8 Inflation and deflation

Question 1

Define hyperinflation. [3]

Answer 1

Hyperinflation refers to very high rates of inflation that are out of control [1], causing average prices in the economy to rise very rapidly [1]. Hyperinflation occurs when the inflation rate is higher than 50% in a month [1].

Question 2

Define deflation. [2]

Answer 2

Deflation is the sustained fall in the general price level in an economy over time [1]. It occurs when the inflation rate is negative [1].

Question 3

Define Consumer Price Index (CPI). [2]

Answer 3

The Consumer Price Index is a weighted index of consumer prices in the economy over time [1]. It is used to measure the cost of living for an average household [1].

Question 4

What are the types of inflation? [4]

Answer 4

• Cost-push inflation
• Demand-pull inflation
• Monetary causes of inflation
• Imported inflation

Question 5

Define cost-push inflation. [2]

Answer 5

Cost-push inflation is a cause of inflation, triggered by higher costs of production [1], therefore forcing an increase in prices [1].

Question 6

Define demand-pull inflation. [2]

Answer 6

Demand-pull inflation is a cause of inflation, triggered by higher level of demand in the economy [1], therefore increases the general price level [1].

Question 7

Define monetary causes of inflation. [2]

Answer 7

Monetary causes of inflation are related to the increases in money supply [1] and easier access to credit such as loans and credit cards [1].

Question 8

Define imported inflation. [3]

Answer 8

Imported inflation is a cause of inflation, triggered by higher import prices [1], forcing an increase in costs of production [1] and causes domestic inflation [1].

Question 9

What are the consequences of inflation? [12]

Answer 9

• Firms need more time to adjust prices
• Cost of living increases
• Customers need more time to search for better charged goods and services
• Money is worth less, savers will lose out
• Money is worth less, leader will lose out
• More borrowers as debt is worth less
• A fall in income of fixed income earners
• Harms the poorest members of society
• Fall in export earnings
• Rise in import cost and cause imported inflation
• Firms’ profits falls as cost of production rises
• A fall in business confidence and investments

Question 10

What are the consequences of deflation? [6]

Answer 10

• Unemployment (fall in demand for labour)
• Bankruptcies of firms
• Fall in the wealth of firms’ stakeholders
• Increase in cost of debts
• Increase in government debt (less taxes)
• Fall in consumer confidence level

Question 11

How can fiscal policy control inflation? [3]

Answer 11

The government can add more taxes [1] in order to reduce the level of consumer spending [1], therefore demand is less [1].

Question 12

How can fiscal policy control deflation? [3]

Answer 12

The government can reduce the level of tax [1] in order to increase the level of consumer spending [1], therefore there is a higher demand [1].

Question 13

How can monetary policy control inflation? [3]

Answer 13

The government can increase the interest rate [1] to encourage people to save more and borrow less [1], therefore the demand will be less [1].

Question 14

How can monetary policy control deflation? [3]

Answer 14

The government can reduce the interest rate [1] to encourage people to spend more and borrow less [1], which cause a higher demand [1].

Question 15

How can supply-side policy control inflation. [3]

Answer 15

The government can increase the level of coperate taxes [1] to discourage firms to invest [1] and cause further inflation [1].

Question 16

How can supply-side policy control deflation? [3]

Answer 16

The government can reduce the level of coperate taxes [1] to encourage firms to invest and take risks [1] and boost the economy [1].

Question 17

Define benign deflation. [3]

Answer 17

Benign deflation is caused by higher levels of supply of goods and services [1] which increases the productive capacity of the economy [1], and the general price level will reduce [1].

Question 18

Define malign deflation. [2]

Answer 18

Malign deflation is caused by lower levels of demand of goods and services [1] which reduces the general price level [1].