Eduqas A Level Economics Inflation and Deflation Exam Questions

About Eduqas A Level Economics Inflation and Deflation

Inflation and deflation is a key macroeconomic objective in the Eduqas specification. You need to understand inflation as a sustained rise in the general price level measured by a weighted price index, be able to calculate simple index numbers, and know the differences between the main UK measures. You analyse demand-pull and cost-push causes, the quantity theory of money, expectations and the wage-price spiral, then evaluate the costs of inflation, which depend on its level, cause and whether it is anticipated. Deflation and its dangers are also included. Examiners frequently test index number calculations and want AD/AS diagrams that clearly separate demand-pull from cost-push inflation.

What you need to know

• Measurement Inflation is the percentage change in a weighted price index, usually over twelve months. The CPI uses a basket of goods and services weighted by household spending, based on the Living Costs and Food Survey. Other measures include CPIH (which adds owner occupiers' housing costs) and RPI.
• Index numbers and weights Index = (value in current year / value in base year) x 100. Weights reflect the share of spending on each item, so a price rise for a heavily weighted item has a bigger effect on the index.
• Demand-pull and cost-push Demand-pull inflation occurs when AD grows faster than the economy's capacity (AD shifts right near full employment). Cost-push inflation occurs when costs such as wages, energy or import prices rise (SRAS shifts left).
• Quantity theory of money MV = PT (or MV = PY). If velocity and output are assumed constant, an increase in the money supply leads to a proportional rise in the price level. Critics argue velocity is not stable.
• Expectations and the wage-price spiral If workers expect higher inflation they bargain for higher wages; firms pass on higher costs as higher prices, which raises expected inflation further.
• Costs of inflation Loss of international competitiveness, menu and shoe leather costs, redistribution from savers and those on fixed incomes to borrowers, uncertainty that reduces investment, and fiscal drag. Costs are greater when inflation is high, volatile or unanticipated.
• Deflation Deflation is a sustained fall in the price level. Benign deflation can come from productivity gains, but malign deflation from weak AD can cause consumers to delay spending, raise the real value of debt and deepen a recession.

Common mistakes in Inflation and Deflation

• Saying prices fall when inflation falls. Lower inflation means prices are still rising, but more slowly; only deflation means falling prices.
• Forgetting to explain why weights matter. A large rise in a lightly weighted item may have little effect on CPI.
• Drawing cost-push inflation as an AD shift. Cost-push inflation is a leftward shift of SRAS.
• Treating all inflation as equally harmful. Evaluate using the rate, the cause and whether it was anticipated.
• Writing the quantity theory without its assumptions. State that V and T (or Y) are assumed constant for the link between M and P to hold.

Try three Inflation and Deflation exam-style questions