Week 12

Question 1

static expectation definition

(types of inflation expectations)

Answer 1

economic agents ignore the fact that inflation can change

Question 2

adaptive expectation definition

(types of inflation expectations)

Answer 2

economic agents believe the future will be like the immediate past

Question 3

rational expectation definition

(types of inflation expectations)

Answer 3

economic agents predict the future by using all available information

Question 4

what are all the 5 available information that rational expectation takes into account

(types of inflation expectations)

Answer 4

• past inflation
• other economic factors
• fiscal policy
• monetary policy
• any relevant information

Question 5

what happens on an AD graph for adaptive expectation of inflation

(application of types of inflation expectations)

Answer 5

• AD shifts outwards increasing the price level which is the price increase expected
• Then SRAS shifts inwards further increasing the price level which is then the price level expected

Question 6

what happens on an AD graph for rational expectation of inflation

(application of types of inflation expectations)

Answer 6

• AD shifts outwards and the price increases
• SRAS shifts inwards then the price level further increases and that is the expected price level

Question 7

what is the difference between the expectations of price level on an AD graph for rational expectation and adaptive expectation

(application of types of inflation expectations)

Answer 7

• adaptive expectation sees the current price level as the expected price level (doesn’t think about possible further shifts)
• while rational would factor all possible shifts and expect the final price level as the expected price level

Question 8

what are the effects of an economy if the factor prices rise

Answer 8

negative short term impact on inflation, growth and unemployment

• SRAS shifts inwards

Question 9

what are the effects on an economy if the factor prices fall

Answer 9

positive short term impact on inflation, growth and unemployment

• SRAS shifts outwards

Question 10

what are the effects on competitiveness of an economy when factor prices rise

Answer 10

• less competitive (prices rise and less output)
• reduced imports

Question 11

what are the effects of competitiveness of an economy when factor prices fall

Answer 11

• more competitive (prices fall increased output)
• increased imports

Question 12

what is the advantage in the short and long term if both the UK and competitors experience inflation

Answer 12

no advantage in the short or long term

Question 13

what is the advantage in the short and long term if the UK didn’t experienced inflation but competitors did

Answer 13

advantage in the short term and unsustainable in the long term (short lived)

(UK prices are lower so more competitive and competitors imports cost more so import less)

Question 14

how can you analyse competitiveness between the UK and other countries

Answer 14

• competitiveness doesn’t change because price levels alter
  –> need to compare price changes with competitors to establish competitiveness
  —> recognise that exchange rate changes will influence outomes
  —–> causes of relative price changes will determine sustainability

Question 15

how does external inflation impact SRAS, AD and LRAS

Answer 15

• SRAS can be impacted (factor costs)
• AD can be impacted (competitiveness)
• LRAS doesn’t get impacted