Inflation

Question 1

What is demand pull inflation?

Answer 1

It’s a rising price level caused by an increase in AD.

Question 2

What are the effects of demand pull inflation?

Answer 2

• Greater pressure on existing factors of production to produce more output
• They become scarce
• They increase in P
• Wages, capital and land go up
• The overall cost of production increases

Question 3

What are the causes of demand pull inflation?

Answer 3

• Decrease in interest rates➡️ increase in C,I and (X-M)
• Decrease in income tax➡️ increase in C and I
• Increase in consumer/business confidence➡️ increase in C and I
• Increase in government expenditure

Question 4

What is cost push inflation?

Answer 4

It’s a rising price level caused by an increase in the costs of production

Question 5

What are the effects of cost push inflation?

Answer 5

Due to the increased cost of production, firms pass on these costs via higher prices of goods.

Question 6

What are the causes of cost push inflation?

Answer 6

• Increase in raw material prices
• Increase in wages
• Increase in business taxes
• Increase in price of imported raw materials due to a weaker exchange rate

Question 7

What are the costs of high inflation?

Answer 7

• Decreased purchasing power assuming wages don’t increase with inflation➡️ a decreased QOL
• Erosion of savings as interest rates aren’t rising with inflation➡️ the savings are losing value
• Decreased export competitiveness harming economic growth
• Wage/consumer price spirals➡️ high inflation is anticipated but it’s spirals causing hyperinflation
• Fiscal drag, when inflation is high and workers are receiving and increased income in line with inflation dragging them into a higher tax band decreasing their QOL

Question 8

What are the benefits of low and stable inflation?

Answer 8

• Workers receive higher wages➡️ there’s an increase in morale
• Consumption is natural ie. they don’t delay or quicken their spending
• Can keep unemployment low in a recession as firms don’t want to fire workers
• Firms are encouraged to increase output➡️ they can increase price earning a higher revenue

Question 9

What are the policies to reduce demand pull inflation?

Answer 9

• Contractionary fiscal policy➡️ Decrease G or increase T
• Contractionary monetary policy➡️ an increase in interest rates

Question 10

What are the costs of the policies to reduce demand pull inflation?

Answer 10

• Decreased economic growth and an increase in unemployment
• High interest rates decreasing investment

Question 11

What are the policies to reduce cost push inflation?

Answer 11

• Implement/reduce inflation target reducing the amount that wages rise in the economy
• Reduce VAT/subsidies to firms
• Intervene in forex markets to strengthen the exchange rate decreasing the prices of imported raw materials