WJEC A Level Economics Inflation and Deflation Exam Questions

About WJEC A Level Economics Inflation and Deflation

Inflation and deflation is an A2 macroeconomic objective in WJEC Economics, organised in the specification around measurement and calculation, causes, costs, solutions and deflation. You need to understand inflation as a weighted change in a price index, usually over twelve months, the differences between the main measures, and how to calculate simple price indices and index numbers. You then explain demand-pull and cost-push inflation, the quantity theory of money, expectations and the wage-price spiral, and evaluate the costs of inflation, which depend on its level, cause and whether it was anticipated. Deflation completes the topic. It is examined in A2 Units 3 and 4.

What you need to know

• Measurement Inflation is the rate of increase in the general price level, measured by the percentage change in a weighted index such as the CPI over twelve months. CPIH adds owner occupiers' housing costs; RPI includes mortgage interest payments and is calculated differently.
• Price indices and weights Index number = (current value / base value) x 100. In a weighted index each item's price change is multiplied by its share of spending, so items households spend more on carry more weight.
• Causes Demand-pull inflation occurs when AD rises faster than capacity; cost-push inflation occurs when SRAS shifts left due to higher wages, energy or import prices. Expectations can create a wage-price spiral.
• Quantity theory of money MV = PY. If velocity of circulation (V) and real output (Y) are stable, an increase in the money supply (M) leads to a proportional rise in prices (P). Monetarists use this to argue that inflation is caused by excess money growth.
• Costs of inflation Reduced price competitiveness, redistribution away from savers and those on fixed incomes, uncertainty that deters investment, menu and shoe leather costs and fiscal drag. Costs are greater when inflation is high, volatile and unanticipated.
• Solutions Contractionary monetary policy (higher interest rates), contractionary fiscal policy, supply side policies to reduce costs and raise productivity, and keeping expectations anchored through a credible inflation target.
• Deflation A sustained fall in the general price level. Deflation caused by weak demand can lead to delayed spending, rising real debt burdens and falling output, while deflation from productivity gains can be benign.

Common mistakes in Inflation and Deflation

• Confusing disinflation with deflation. Disinflation is a fall in the rate of inflation; deflation is falling prices.
• Calculating inflation from index numbers by subtracting them. Use the percentage change: (new - old) / old x 100.
• Stating the quantity theory without assumptions. The link from M to P depends on V and Y being stable.
• Treating raising interest rates as the right response to every type of inflation. Against cost-push inflation it can reduce output and raise unemployment.
• Assuming all deflation is harmful. Distinguish between malign and benign deflation.

Try three Inflation and Deflation exam-style questions