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Economics IB - Inflation Essay

Economics IB - Inflation Essay

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07/25/2013

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Tra My Nguyen (Magda)IB1HOMEWORK -
Inflation Essay
 
[30.04.2010]
Word Count:
a.
Explain possible causes of a rise in the rate of inflation in aneconomy: (1073)
Firstly, what does the concept “inflation” mean? “Inflation” is defined as a persistentincrease in the average price level in the economy, usually measured through thecalculation of a consumer price index (CPI), which is measuring the price of the largeamounts of different types of goods and services demanded. Inflation is assessed bycomparing the prices of similar goods at two different periods of time, assuming thequality to remain the same.When the prices of goods and services go up, it means that the purchasing power will be reduced. With the same amount of money, people will not be able to buy as much asthey could in the previous period of time (e.g: previous year). There are many differenttypes of inflation, such as: single-digit inflation, double-digit inflation, gallopinginflation, hyper inflation, etc. One of the very significant examples of this is the hyper inflation in 1913 in Germany. Before the World War I, we could change 1 USD into 4Marks, but after 10 years, 1 USD was equal to 4 billion Marks. So in suggests thatinflation growing depends not only on the length of period of time considered, but also onthe country condition at that period of time (e.g: war).So what are the causes of inflation? There have been agreed 3 main causes that leadto inflation: demand-pull inflation, cost-push inflation and inflation due to excessmonetary growth.
Demand-pull inflation
The demand-pull inflation occurs as a result of increasing aggregate demand in theeconomy. It can be simply shown as in the Figure 1 below:Inflation Essay30.04.2010
 
a.Explain the possible causes of a rise in the rate of inflation in aneconomy. (10p)b.Evaluate the possible impact on economic performance that mayresult from a government decision to bring inflation under control.15
 
Tra My Nguyen (Magda)IB1
{Figure 1}In this figure, when the demand increases, AD
1
shifts to the right to AD
2
, alsocausing the real output to increase from O
1
to O
2
, which results in the increase in average price level, from P
1
to P
2
. And there occurs the inflation, since the prive level has been pulled up by the demand. So it is called demand-pull inflation.There are also two morecases where the demand-pull inflation is likely to occur, shown in Figure 2 and Figure 3.That is when the economy is approaching full employment (figure 2) or when theeconomy is at its level of full employment (figure 3).Inflation Essay30.04.2010Real output0SRASAD
2
AD
1
O
1
O
2
LRASAD
2
AD
1
O
2
O
1
P
1
P
2
0Real output{Figure 2}Average price levelP
2
P
1
Average price level
 
Tra My Nguyen (Magda)IB1
As the demand increases, the AD
1
curve will be shifted to the right to AD
2
, passing through the small amount of spare capacity, causing the prive level to increasefrom P
1
to P
2
along with the increase in real output from O
1
to O
2
. And therefore, thedemand-pull inflation takes place.When the AD curve has passed through the whole spare capacity, it reaches thelevel of full employment, which is shown below:{Figure 3}Here, since the AD curve has reached the level of full employment, it is unable toexpand the output as the demand increases, however the price still keeps increasing when people are buying more. And there occurs the demand-pull inflation.
Cost-push inflation
The second of the three main causes is the cost-push inflation, that is the result of an increase in the costs of production.{Figure 4}Inflation Essay30.04.2010LRASAD
1
AD
2
Average price levelReal outputOP
1
P
2
0

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