2.1.2 Inflation & Deflation Exam Questions 6/10/12/15/20/25 markers

With reference to Extract A, explain two likely economic effects of the higher rate of UK inflation (6 marks)

K= Real value of personal debt falls

(Application 1 marker)

- Borrowers will benefit as the real value of their loan repayments are reduced over time (1)

K= MPC raises base rate of interest

(Application 1 marker)

- Increases the cost of borrowing / reward for saving, hence consumption falls (1)

With reference to the last paragraph of Extract A and Figure 2, explain one reason why it is necessary to regularly update the CPI basket of goods and services (5 marks)

K= To ensure that inflation/cost of living/CPI basket is accurately measured (1)

(Application 1 marker)

Analyse: To ensure that inflation/cost of living/CPI basket is accurately measured (1)

Evaluate the likely impact of high inflation on the UK goverment's macroeconomic objectives. (20 marks)

May reduce growth owing to costs of inflation • Reduction in purchasing power and real incomes • Equality e.g. effect on those who have fixed incomes (are not protected by inflation) who are often the poorest • May make the national debt smaller in real terms making it cheaper to finance and pay back • Reduction in competitiveness of British goods which worsens the current account of the balance of payments deficit and reduces international competitiveness • Unemployment may rise through increased levels of inefficiency and stagflation / using a Phillips curve

Evaluation: Depends on the cause, (e.g. cost push or demand pull) duration and magnitude of inflation - may be discussed in recent context of the UK / using AD AS diagram • Inflation might not translate through to higher wages and unemployment if the workforce has little power • If growth is low, slightly higher inflation is worth the risk to avoid deflation or depression

7) With reference to the information provided and your own knowledge, examine two factors which might explain the change in the rate of Eurozone inflation as shown in Figure 2. (8 markers)

K= Falling oil prices

Application (1 marks)

Analyse= Falling oil prices in the world economy reduce key costs of production such as transportation (1 marks)

Evaluation: Oil prices are very volatile and could easily rise rapidly due to world events such as instability in

the Middle East (1 mark)

K= government fiscal tightening

Application (1 marks)

Analyse: Decrease government spending and increasing tax cause a decrease in circular flow

Evaluation: Depends on extent of fiscal tightening by

government

Q8) (a) With reference to the data, explain two likely reasons for the UK's falling inflation rate. (6 marks)

K= Falling energy prices

Application= 1 mark

Analysis= falling oil prices makes transport of goods

cheaper (1)

K= Slowdown in consumer spending

Application= 1 mark

Analysis= less spending (makes 60% of AD) decreases aggregate demand

Q8) b) With reference to Extracts A and B and your own knowledge, discuss whether the

MPC should be concerned about the risk of deflation in the UK economy.

K= Risk of deflationary spiral; hard to 'escape' from

such a situation

Eval= Likely to be only short-term/caused by one-off

factors that will disappear from the statistics after

one year

K= Consumer expectations of very low/falling prices

become embedded

Eval= Economic growth and incomes are still rising in

the UK economy, suggesting inflation is not

affecting consumer demand

K= Harder for MPC to react to/influence supply-side

factors such as falling oil prices

Eval= Caused by supply-side factors rather than

demand-side, so less of a problem for the UK

economy

Q8) c) Evaluate whether the MPC has been successful in controlling the UK's inflation rate since 2011.

K= According to Figure 2 highest inflation rate was

only just over 5%, good by historical standards

Eval= Figure 1 shows inflation has often been outside of range of +/- 1% from the 2% target

K= Regular monthly MPC meetings implies flexibility

Eval= Interest rates have stayed at 0.5% for a long

K= QE helped to avoid risk of deflation during global

economic crisis

Eval= MPC struggles to respond to supply-side factors, e.g. rising food/commodity prices in 2008/9 and now falling prices in 2014

K= Independent of government

Eval= Banking failure

Q9) a) (ii) With reference to the information provided, explain two causes of the fall in the UK's rate of inflation since 2012. (8 marks)

K= Falling oil price

Application 1 mark

Analyse: (2 marks)

K= Falling commodity prices

Appliacation 1 mark

Analyse: (2 marks)

Q9) (b) With reference to the information provided, discuss two likely effects of a fall in the average price level on the UK economy. (12 marks)

K= Falling consumption as consumers hold off

purchases in expectation of further falls in

price

Falling consumption as consumers hold off

purchases in expectation of further falls in

price (deflationary spiral)

Eval: - consumption is still high

K= mproved competitiveness & reduced

current account deficit

- increase in consumers' real income &

therefore AD

Eval: - magnitude of change in price level

Q10) a) Explain how the CPI measure of inflation is calculated. Refer to the concept of

weighting in your answer. ( 6 marker)

K= Weights are attached to reflect relative

importance of items (1) in terms of

consumer spending/income (1)

Price survey

• Expenditure and Food Survey

• Basket of goods / 650 goods and services

• Contents of the basket revised annually

• Use of an index

• Base year

• Price changes multiplied by weightings

(6)

Question

Number

Q10) b) Explain two factors that might encourage the Monetary Policy Committee of the Bank of England to increase the UK base rate of interest. (8 marker)

K= Inflation above target

K= Consumer / business expectations of

future price rises

Q10) (c) Examine whether a very low rate of inflation is desirable for the UK economy. (12 marker)

K=

Exports may increase and imports

may decrease, improving UK trade

balance and competitiveness

Evaluation: expectation of falling prices in the

future discourages purchases today;

consumption and therefore AD falls

K=

May lead to higher real wages or less

erosion of fixed incomes, hence more

spending

Evaluation: May lead to increased unemployment

Q11) a) Evaluate two benefits of low and stable inflation for the UK economy (12 marks)

K= • Improved confidence among consumers and so supporting spending

Eval= • Potential offsetting macro consequences e.g. higher unemployment

K= • Improved confidence among firms and so improving investment

Eval= • Lack of demand-pull inflation implies economy is doing badly

K= •• Improved international competitiveness

Eval= • Relative importance of each impact (imports only make up 1% of AD)

Q12) (a) Explain two reasons why the government has a low rate of inflation as a macroeconomic objective. (8 marks)

K=Help reduce inequality as inflation damages those on fixed incomes

K= • Maintain international competitiveness

Q12) (b) With reference to the information provided, evaluate the significance of two likely causes of UK inflation over the period 2008 to 2012. (12 marks)

K= Weakening exchange rates leading to the increased cost of imported components

Eval= Fixed contracts limit impact of exchange rate

depreciation

K= Rising price of oil which is used by most businesses either directly or indirectly and the UK is a net importer

Eval= • PED for imports

Q14) (a) Explain how the Consumer Price Index (CPI) is calculated. (6 marks)

efinition of CPI: a measure of the average price level of goods and

services in the UK

• Price survey

• Expenditure and Food Survey

• of approximately 7,000 households

• Basket of goods

• containing approximately 650 goods and services

• Contents of the basket revised annually

• Weighted average

• Weights are attached to reflect relative importance / further

explanation of calculation (1+1)

• Use of an index

• Base year

• Data is published monthly

• Exclusion of most housing costs

Q14) (b) Analyse two possible reasons why the CPI measure of inflation was above its target range in 2011. (8 mark)

P= • Rising import prices (2) such as oil/commodity prices (2)

P= • VAT rises (2) increasing the price of products sold (2)

Q14) (c) Explain two likely economic consequences of inflation falling "below the 2% target" (Extract 3, lines 5-6). (8 mark)

- If nominal wages rise faster/gap between wage increase and inflation less large (2) then real incomes rise / real incomes not falling as fast

(2) which may raise consumption (2)

- Danger of falling into deflation if inflation rate goes below zero (2) and hence consumption delayed (2)

Q15)(b) In Extract 1, the UK's rate of inflation is predicted to be significantly lower in 2012 than in 2011. Explain two likely economic consequences of the lower rate of inflation in 2012. (8 marks)

K= Greater economic confidence among

consumers (2) and thus more spending (2)

• Unexpectedly higher real wages or

unexpectedly less erosion of fixed incomes

(2) and thus more spending (2)

K= lower wage demands, lower input costs (2)

increasing price competitiveness (2)

• Exports may increase and imports may

decrease (2), improving the trade balance (2)

OR leading to an appreciation in the value of

the pound (2)

Q16) (a) With reference to Extract 2, analyse two of the causes of inflationary pressure that the Governor views as "temporary" (8 marks)

K= How increase in VAT affects CPI inflation (2)

K= Oil as a cost of production relevant to most goods and services (2)

Q16) (b) In light of the information provided, assess the case for an increase in the base interest rate set by the Monetary Policy Committee. (12 marks)

K= • Inflation is above the MPC's target and tolerance

Eval= Greater concern about potential deflationary spiral if consumption collapses

K= Lowering relative inflation should increase international competitiveness

Eval= Raising interest would strengthen sterling and reduce exports' competitiveness

and further weaken AD

Q18) (b) explain two reasons why the government has a low rate of inflation as a macroeconomic objective. (8 marks)

K= • Inflation damages those on fixed incomes

K= • Maintain international competitiveness

Q20) (b) Using the evidence from Extract 1 and Figure 1, analyse two possible reasons why the MPC took the decision to cut the official interest rate in February 2008. (10 marks)

K=Prospects for output growth have worsened

K= Disruption to global financial markets