Lesson 26-Inflation

Question 1

Define the term inflation

Answer 1

Inflation is the continuous increase in the price levels over a period of time in an economy

Question 2

What are the two types of inflation?

Answer 2

Demand pull inflation
Cost push inflation

Question 3

Define Deflation

Answer 3

A fall in the average price level as a result of fall in the level of aggregate demand

Question 4

How is inflation measured?

Answer 4

Inflation is measured with the aid of the consumer price index

Question 5

Explain Demand Pull Inflation

Answer 5

This is inflation caused as a result of the aggregate demand exceeding the aggregate supply of goods and services. When suppliers cannot meet the increasing demand, they are compelled to increase prices to restrict demand.

Question 6

What does aggregate demand consist of?

Answer 6

Consumer expenditure
Investment expenditure
Government expenditure
Net exports

Question 7

Explain Cost Push Inflation

Answer 7

Occurs when the price level of a country increases due to an increase in the cost of production of firms. An increase in cost of production will compel firms to increase prices to maintain their profit margin.

Question 8

Describe the relationship between inflation and interest rates

Answer 8

If there are low interest rates people will borrow more money and save less money. therefore people will spend more hence demand for goods and services will increase. Suppliers will not be able to meet this high demand so they will be compelled to increase their prices resulting in inflation. Vice versa

Question 9

State the impacts of inflation (7)

Answer 9

1. Inflation reduces the real income of fixed income earners.
2. Raises the cost of living thus reducing their standard of living
3. Consumers will import cheaper goods which will lead to a deficit on the current account of the BOP
   4.Borrowers gain at the expense of lenders
4. It will reduce exports of a country as the good wil be more expensive for other countries resulting in deficit in the BOP
5. Firm will not expand which will hinder economic growth
6. Consumers will spend less therefore AD will be less which will lead to fall in jobs and unemployment will rise.