Essay Plans

Question 1

Q: Using diagrams, explain the difference between demand-pull and cost-push causes of inflation. [8]

AO1: Define Inflation

Answer 1

Inflation refers to the general sustained upward motion in price of goods and services in an economy over a given time period, specifically 2/4 quaters / 6 months

Question 2

Q: Using diagrams, explain the difference between demand-pull and cost-push causes of inflation. [8]

AO1: Demand-pull causes of inflation

Answer 2

• Demand-pull inflation, is caused by an outward shift in Aggregate Demand
• AD is the total demand for goods and services in an economy and it consists of consumption, investment, government spending and net exports
• An increase in any of these 4 factors would cause AD to shift outwards, therefore leading to demand-pull inflation
• Ex: If income tax rates are lowered, we can expect consumption to increase, leading to demand-pull inflation

Diagram for Demand-Pull Inflation

Question 3

Q: Using diagrams, explain the difference between demand-pull and cost-push causes of inflation. [8]

AO2: What does the demand-pull inflation diagram show us?

Answer 3

• Increase in GPL
• Increase in RGDP

Question 4

Q: Using diagrams, explain the difference between demand-pull and cost-push causes of inflation. [8]

AO1: Cost-push causes of inflation

Answer 4

• Cost-push inflation is caused by an increase in the cost of production for firms, meaning SRAS shifts inwards
• An example of a factor affecting cost-push inflation includes the increase in prices of raw materials, such as oil and gas

Diagram for Cost-Push Inflation

Question 5

Q: Using diagrams, explain the difference between demand-pull and cost-push causes of inflation. [8]

AO2: What does the cost-push inflation diagram show us?

Answer 5

• Increase in GPL
• But unlike demand-pull inflation, there is a decrease in RGDP, which indicates negative economic growth

Question 6

Q: Using diagrams, explain the difference between demand-pull and cost-push causes of inflation. [8]

AO1 + AO3: Conclusion + Evaluative point

Answer 6

• In conclusion, demand-pull inflation is caused by an increase and therefore outward shift in AD
• Cost-push inflation is caused by an increase in the cost of production and therefrore an inward shift in SRAS
• However, the impacts of this inflation that have been discused are dependent on the size of the inflation
• The impacts are also assuming ceteris paribus; For example, we assume that the only way for output to increase is by there being demand-pull inflation, when there are actually other external factors that could influence this

Question 7

Q: Distinguish between the domestic and external consequences of inflation and discuss which is most damaging to an economy. [12]

AO1: What is inflation + what is meant by internal and external?

Answer 7

• The general sustained upward motion in price of goods and services in an economy, over a specific time period, specifically 2/4 quaters / 6 months
• Internal consequences of inflation, refers to consequences faced by the domestic economy
• While external consequences, refer to damages that affect international transactions between local and foreign economies

Question 8

Q: Distinguish between the domestic and external consequences of inflation and discuss which is most damaging to an economy. [12]

AO1 + AO2: What are the domestic consequences of inflation?

Investment related

Answer 8

• Can discourage investment into an economy
• Due to the unpredictability and risks associated with investing and the rate of inflation, investors will be less incentivised to invest
• Instead, they will adopt a wait-and-see approach or they may even avoid investing all together, which will cause a decrease in Aggregate Demand in the economy
• Which should lead to a reduction in real output and an increase in unemployment

Question 9

Q: Distinguish between the domestic and external consequences of inflation and discuss which is most damaging to an economy. [12]

AO1 + AO2: What are the internal consequences of inflation?

Purchasing power related

Answer 9

• Inflation leads to a decrease in the purchasing power of the domestic currency
• This benefits some parties and disadvantages others
• For example, this disadvantages savers, as they real value of their savings as fallen due to an increase in GPL

Question 10

Q: Distinguish between the domestic and external consequences of inflation and discuss which is most damaging to an economy. [12]

AO1 + AO2: What are the external consequences of inflation?

Export, Import and Current Account Deficit related + Think about AO3 evaluation relating to imports, exports and current account deficits

Answer 10

• Inflation leads to an increase in the general price level
• This will make the exports less competitive in international markets, since the prices would have increased for the goods being exported
• This increase in price, also means that domestic consumers will seek to find imported versions of certain goods for cheaper than the domestic prices
• This means domestic consumers have an increased marginal propensity to import
• This decrease in exports and increase in exports, can lead to a current account deficit
• A current account deficit is when the value of goods imported exceeds the value of goods being exported

***AO3: However, this assumes the price elasticity of demand for our exports is price elastic. However, if the PED was price inelastic, it could actually lead to a current account surplus and would allow the economy to enjoy higher revenues

Question 11

Q: Distinguish between the domestic and external consequences of inflation and discuss which is most damaging to an economy. [12]

AO3: Which consequences are more severe, internal ore external?

Plus conclusion

Answer 11

• Depends on an economies openness to trade
• If an economy is open to trade and net trade makes up a large proportion of AD, then external consequences will have more of an impact on the economy
• This is because the external consequences involve a decrease in exports and an increase in imports, which assuming ceteris paribus, should result in a current account deficit

Question 12

Q: Explain how a rise in the rate of interest might cause a shift in an economy’s aggregate demand curve? [8]

AO1: Definitions / Introduction

Answer 12

• The rate of interest is a percentage, which refers to the reward of saving and the cost of borrowing.
• Aggregate demand refers to the total demand for all goods and services in the economy and comprises of consumption, investment, government spending and net exports
• Formula: AD = C + I + G + (X-M)

Question 13

Q: Explain how a rise in the rate of interest might cause a shift in an economy’s aggregate demand curve? [8]

AO1: How does interest rates affect the different components of AD?

This is a big flashcard. Just think, how do interest rates affect each component of AD

Answer 13

Consumption:
* If the rate of interest increases, then it means the reward for saving will be greater, meaning consumers are more incentivised to save
* The cost of borrowing will also be higher, which disincentivises consumers to make big ticket purchases such as cars
* Meaning their marginal propensity to consume decreases
* Which results in a decrease in consumption

Investment:
* If the rate of interest is high, then it means the cost of borrowing is higher
* Meaning firms are less likely to invest in capital goods that will improve productive capacity
* Therefore causing investment to decrease

Government Spending:
* Interest rates have no impact on government spending

Net Exports:
* A rise in the rate of interest can lead to an appreciation of the currency due to hot money flow
* This phenomenon states that investors and consumers will be more likely to put their savings in banks located in country’s with high interest rates as it allows them to maximise their return
* Appreciation = SPICED, which means that exports will become dere and imports will become cheap. If we assume that PED is price elastic, then this means that net exports will decrease as M is greater than X

Question 14

Q: Explain how a rise in the rate of interest might cause a shift in an economy’s aggregate demand curve? [8]

AO3: Evaluation

Answer 14

• In this answer, I have assumed ceteris paribus, specifically, that the only factor influencing the components of AD is the interest rate
• However, there are other factors that may influence C, I, G and, (X-M)
• For example, we have assumed that if interest rates rise, consumption will decrease, as the reward for saving increases
• However, if the government decrease the VAT charge or the rate of income tax, then it is incentivising consumers to consume, which may lead to an increase in consumption, even though the rate of interest has risen

Question 15

Q: Discuss whether inflation is more likely to be caused by a shift in an economy’s aggregate demand or a shift in its aggregate supply? [12]

AO1: Definitions / Introduction

Answer 15

• Inflation refers to the general sustained upward motion in price of goods and services in an economy, over a given time period, specifically 2/4 quaters / 6 months
• Aggregate demand refers to the total demand for all goods and services in an economy
• Aggregate supply, refers to the total supply of goods and services produced in an economy

Question 16

Q: Discuss whether inflation is more likely to be caused by a shift in an economy’s aggregate demand or a shift in its aggregate supply? [12]

AO1 + AO2: Disucss how a shift in AD can cause inflation and the impacts

Answer 16

• Inflation can be caused by an outward shift of AD, which consists of consumption, investment, government spending and net exports
• This type of inflation is known as demand-pull inflation
• Therefore an increase in any component of AD will lead to demand-push inflation
• As evidenced by the diagram we can also see that this type of inflation will lead to an increase in RGDP, (real output)
• It will also lead to an increase in employment, moving closer to YFE

Demand-Pull Inflation

Question 17

Q: Discuss whether inflation is more likely to be caused by a shift in an economy’s aggregate demand or a shift in its aggregate supply? [12]

AO3: What if an economy is operating at full employment

Answer 17

• However, if an economy is operating at full employment, then there will only be a temporary increase in output
• This is because output cannot be sustainably increased beyond our productive potential in the long run
• Meaning that output will eventually return to what it was when the economy was at full employment

Question 18

Q: Discuss whether inflation is more likely to be caused by a shift in an economy’s aggregate demand or a shift in its aggregate supply? [12]

AO1 + AO2: Discuss how a shift in SRAS can cause inflation and impacts

Answer 18

• Cost-push inflation can be caused by a decrease in SRAS
• A decrease in SRAS is the result of an increase in the cost of production, which could be due to many factors, such as an increase in the price of raw materials
• If there is cost-push inflation, then it means that there is a decrease in output, which also leads to a decrease in unemployment

Insert diagram for Cost-Push Inflation to show points

Question 19

Q: Discuss whether inflation is more likely to be caused by a shift in an economy’s aggregate demand or a shift in its aggregate supply? [12]

AO2/AO3: Analyse likeliness of inflation being caused by AD / SRAS shift

2 factors

Answer 19

• Depends on the stage the economy is within the business cycle
• The business cycle refers to fluctuations of economic activity in an economy
• For example, if an economy is in a recession, then they are less likely to experience demand-pull inflation, as there is lots of uncertainty, which incentivses consumers to save, which therefore decreases their marginal propensity to consume, leading to a decrease in AD
• Another factor that affects the likeliness of inflation to be cost-push or demand-pull is the availability of raw materials
• For example, if an economy has been affected by a war or a natural disaster, then the cost of certain raw materials may increase, leading to a higher cost of production for firms
• Meaning that firms within the economy should experience a rise in their cost of production, leading to cost-push inflation

Question 20

Q: Discuss the policy options available to a government faced with inflation, and consider which is most likely to be effective. [12]

AO1: Definitions / Intro

Answer 20

• Inflation refers to the general sustained upward motion in the price of goods and services in the economy over a given time period, specifically 2 quarters / 6 months
• There are 3 types of policy that could be used when the government is faced with inflation
• Fiscal policies, are those concerning taxation and government spending
• Monetary policies, are those to do with interest rates, money supply and the exchange rate
• And finally, Supply Side policies aim to increase the productive capacity of an economy
• Fiscal and monetary policies are used when faced with demand-pull inflation
• Supply side policies are used when faced with cost-push inflation

Question 21

Q: Discuss the policy options available to a government faced with inflation, and consider which is most likely to be effective. [12]

AO1: Discuss how fiscal policies could be used in the face of inflation

Answer 21

• Fiscal policies invovle taxation and government spending
• Contractionary fiscal policies can be used to slow down inflation in an econonmy and can even lead to disinflation
• Some examples of this invove increasing the rate of income taxation
• This means that consumers will have less income to spend on consumption, meaning they will have a lower marginal propensity to consume, which should lead to AD shifting inwards, which would reduce demand-pull inflation
• However, for lots of economies, they target a specific rate of inflation, (in the UK this is 2%)
• If an economy is below the target rate, then the government can use expansionary fiscal policies to stimulate inflation
• Such as increasing government spending
• This will cause an outward shift in AD

Question 22

Q: Discuss the policy options available to a government faced with inflation, and consider which is most likely to be effective. [12]

AO1: Discuss how monetary policies could be used

Answer 22

• Monetary policies can also be used to stimulate and slow down inflation
• For example, if the government wants to reduce the rate of inflation, then they could increase interest rates
• This gives consumers a greater reward for saving meaning their marginal propensity to save increases, which will reduce consumption
• And this also means that firms will have higher cost of borrowing, meaning that investment should decrease
• However, the government could also use expansionary monetary policies to increase inflation, which would involve potentially lowering interest rates to incentivise consumer spending

Question 23

Q: Discuss the policy options available to a government faced with inflation, and consider which is most likely to be effective. [12]

AO3: Discuss the main weakness fiscal policies

Answer 23

• Fiscal policies have one main weakness, which is that they often take a long time to be implemented
• Meaning if we are looking to control inflation in the long-run, they can be very useful, however, in the short-run they may be ineffective

Question 24

Q: Discuss the policy options available to a government faced with inflation, and consider which is most likely to be effective. [12]

AO1: Discuss how supply side policies could be used

Answer 24

• Supply side policies aim to increase AS through the means of making an economy more efficient
• This outcome can be achieved, through several different methods, such as training programmes or the government could encourage long-term competitiveness through privatisation and deregulation
• This would cause an outward shift in our LRAS Curve which would lead to an increase in output and decrease the general price level

Question 25

Q: Discuss the policy options available to a government faced with inflation, and consider which is most likely to be effective. [12]

AO3: What is the weakness of supply side policies?

Answer 25

• Supply side policies have two main weaknesses
• Firstly, the effects are usually only effective in the long-run
• For example, training programmes may take a long time
• The second weakness, is that they may not work
• For example, if the government hosts training programmes to increase productivity, there may be so many people at the programme, that people cannot get much 1 to 1 help, meaning they may not become any more productive

Question 26

Q: Discuss the policy options available to a government faced with inflation, and consider which is most likely to be effective. [12]

AO3: What factors do the policy used depend on? + Conclusion

Answer 26

• The type of inflation
• If it is demand-pull then the government should use fiscal or monetary policies to control it
• However, if it is cost-push then the government should use supply side policies to control the inflation
• The time period
• This is because certain policies, such as supply and fiscal policies may be more effective in the long-run
• Meaning that if the policies are looking to control inflation in the short-run, then the government will have to factor this in when choosing the appropriate policy to control inflation

Question 27

Q: Explain the difference between fiscal and monetary policy. Show how each can be used to increase aggregate demand. [8]

AO1: Introduction

Answer 27

• There are two types of policies that an economy can rely on in order to influence aggregate demand
• Fiscal policies refer to when the government make changes in taxation or government spending in order to influence AD
• Monetary policies refer to changes in interest rates, money supply or the exchange rate, with the intent of influencing AD

Question 28

Q: Explain the difference between fiscal and monetary policy. Show how each can be used to increase aggregate demand. [8]

AO1: Discuss how fiscal policies can increase AD

Answer 28

• Fiscal policies that are designed to increase AD are known as expansionary fiscal policies
• The first of these that can increase AD is a reduction in taxation, specifically direct taxes such as income tax and corporation tax
• If the government lower the rates of income tax in an economy, then it means consumers will be paying less money to the government and will therefore have more real disposable income
• This means that their marginal propensity to consume will increase, as they feel richer as they have more real disposable income
• This should cause an increase in Consumption, assuming ceteris paribus, which will lead to an increase in AD
• Another expansionary fiscal policy that the government could adopt is an increase in government spending
• For example, an increase in the amount spent on healthcare or education
• Government spending is a key part of AD and this should therefore increase AD

Question 29

Q: Explain the difference between fiscal and monetary policy. Show how each can be used to increase aggregate demand. [8]

AO1: Discuss how monetary policies can increase AD

There is also some AO3 in here

Answer 29

• Expansionary monetary policy increases AD
• Reduction of interest rates
• Reward for saving decreases, which incentivises consumption, meaning consumers have a greater marginal propensity to consume
• This also means there is a lower cost of borrowing meaning consumers are more likely to purchase big ticket items, like cars
• This lower cost of borrowing also leads to an increase in investment on capital goods to improve productive capacity
• Consumption and investment are both key components of AD, so assuming ceteris paribus, this should cause an increase in AD
• If an economy operates under a fixed exchange rate system, then the centeral bank of that country could lower the exchange rate
• Meaning that exports become dere and imports become cheap, (WPIDEC)
• This means that assuming the goods exported and imported are price elastic, lead to more being generated from export revenues than is being spent on imports
• Meaning X is greater than M, which is a key component of AD, meaning AD should shift outwards

Question 30

Q: Explain the difference between fiscal and monetary policy. Show how each can be used to increase aggregate demand. [8]

AO2: What are the impacts of an increase in AD

Answer 30

• Increase in RGDP, indicating economic growth
• Also indicates a reduction in unemployment
• Ultimately though, this leads to an increase in GPL, causing demand-pull inflation

Question 31

Q: Explain the difference between fiscal and monetary policy. Show how each can be used to increase aggregate demand. [8]

AO1: Conclusion, (Summarise the differences)

Answer 31

• Fiscal policies effect taxation and government spending
• Monetary policies affect interest rates, money supply and exchange rates