Define the term inflation.
A sustained increase in the general price level for goods and services.
In which of the following situations is an economy suffering from disinflation?
A- The annual rate of inflation changes from 4% to 2.5%
B- The annual rate of inflation has changed from -2% to -1%
C- The annual rate of inflation is zero
D- The annual rate of inflation is constant 2%
A
Explain why economists might be interested in the UK's core inflation rate.
The core inflation rate is a measure of inflation, which is based on the CPI but excludes certain products whose prices are volatile. economists might be interested in the UK's core inflation rate because it measures the underlying rate of inflation in the economy by excluding items subject to short term fluctuations.
In which of the following situation is an economy suffering from deflation?
A- The annual rate of inflation is falling from 4% to 2.5%
B- The annual rate of inflation has risen from 2% to 5%
C- The annual rate of inflation is zero
D- The annual rate of inflation is constant at -2%
D
Explain why governments try to avoid periods of deflation.
Deflation is the persistent fall in the general price level of goods and services. Governments try to avoid periods of deflation because households and firms are less willing to spend money and extremely reluctant to finance consumption or investment by borrowing, as the value of these debts will increase too. Deflation causes households and firms to reduce expenditure.
Which of the following is an example of demand pull inflation?
A- A rise consumer confidence and the level of consumption
B- A rise in the price of wheat
C- A rise in average real wages
D- A rise in the rate of inflation in a major trading partner
A
Explain how a depreciation in the value of the pound might result in demand pull inflation.
Deflation is a fall in the value of a country's currency against other currencies. Demand pull inflation is a rise in the general rice level that results form an increase in aggregate demand. If a county's exchange rate falls against other currencies, it means that more of that currency is needed to buy a unit of another currency. Depreciation of a currency has two important consequences: the price of exports overseas declines and the price of imports in that country rises. Both of these factors can contribute to a rise in aggregate demand. demand for exports may rise, and that for imports fall, and these effects will be greater if demand for exports and for imports is price elastic. Rising exports and falling imports will boost aggregate demand by increasing the value of net exports component of aggregate demand. Some of the demand for imports may be switched to domestically produced goods and services, increasing consumption and boosting aggregate demand further.
Explain the effects of sustained fall in real wages, such as that experienced in the UK recently, on the rate of inflation.
Real Wage is the nominal wage adjusted for inflation. If real wages fall, the result is decreasing unit labour costs. this means that the cost of the labour input to a unit of output rises. this allows firms to relax prices as their costs have decreased, especially if wages are a high proportion of total cost, and this decreases inflationary pressures.
Explain why changes in the prices of commodities such as wheat and oil can have a significant impact on the rate of inflation in the UK.
The UK imports many of the commodities it requires. Commodities make up a substantial proportion of the UK's imports. Expenditure on imports of minerals and foodstuffs totalled £127 billion or 20.03% of total UK imports. As a result, changes in the price of commodities such as wheat and oil on world markets can have a significant effect on the rate of inflation in the UK via the cost push mechanism.
Explain the possible effects of the growth of emerging economies such as China and Brazil on the rate of inflation in the UK.
The UK economy is becoming more integrated with other economies as a consequence of the process of globalisation whereby many markets are becoming international in nature. This means that the potential for events in other economies to have an impact on the UK economy is growing. The UK has benefitted in some ways from the high rates of economic growth in emerging economies such as China and Brazil. The rapid growth of the Chinese economy has been based on its enormous supply of low cost labour, enabling it to manufacture goods cheaply. this has helped inflation to stay low. Research by the Bank Of England suggests that cheap imports from Chins reduced UK inflation by about .2%per annum over the period 200-04.
However, activities in emerging markets also have the potential to add to UK inflation. Rising demand for some globally traded commodities in huge economies such as China and Brazil can lead to price rises as supply of the products becomes relatively low. This can be seen in the rising demand for minerals such as oil, copper and iron ore but also in the rising demand for some food products as consumers' incomes increase in these countries. This has the potential to increase global prices and to impact on the rate of inflation in the UK.
