Title: Inflation Date: 03/12/21

Starter:
a) Using a supply and demand diagram, analyse the
impact of a tax placed on producers on the market for
petrol. (6 marks)
Extension question
b) Are there any other ways we could end up at this level
of consumption? Explain each answer
Learning Objectives

● To understand how inflation is measured

● To understand the main causes of inflation
Inflation is… the sustained rise in the price level of goods
and services over a period of time.
Deflation is the sustained fall in the price level of goods
and services over a period of time. (negative inflation)
Inflation is… the sustained rise in the price level of goods and services
over a period of time.
Deflation is the sustained fall in the price level of goods and services over
a period of time. (negative inflation)

Note: be careful when talking about a rise or fall in the rate of inflation
If inflation is at 10% and falls to 5% (the rate of inflation is going down) this
does not mean we have deflation. This is called disinflation.
Lowest inflation rates across the world
Highest inflation rates across the world
Notable countries (when I taught this last year)

Country Inflation rate (%)

Mongolia 9.7
United Kingdom 4.2
United States 6.2
China 1.5
Russia 8.13
Notable countries (this year)

Country Inflation rate (%)

Mongolia 13.8
United Kingdom 10.1
United States 8.2
China 2.8
Russia 13.7
Calculating the level of inflation
We know that to calculate inflation we use a price index, looking at
how prices of goods and services change from year to year (or month
to month).

What makes a good price index?

- Base year - a stable, uneventful base year
- A weighted basket of goods - the goods and services we use
most often have the most impact on the price index
Your task is to give a weighting to each of the goods in the
following ‘basket’, based on how important you think they are.
Remember these weightings must add up to 100%.
Marks will be given if you are within 2% of the real weighting!

Example:
Clothing and footwear 5%
Housing and household services 6%
Depending on which categories rise more than others
depends who is affected by inflation the most.

Eg. If university fees rise significantly, families with children at

university will be affected more than families with younger
children.
Causes of inflation

The causes of inflation are grouped into two main categories.

1) Cost-push inflation
2) Demand-pull inflation
Cost-Push Inflation
Cost-push inflation is when business respond to rising production
costs by increasing the prices of their goods or services.
Causes of rising production costs can include:
- A minimum wage being introduced
- Rising costs of raw materials
- An increase in indirect taxes (taxes on production)

This can cause the wage-price spiral to occur….

Demand-Pull Inflation
Demand-Pull inflation occurs when we have a rapid increase
in aggregate demand, the economy is growing too fast. The
price level is being ‘pulled’ up by excess demand, often
happening during an ‘economic boom’.
If there is spare capacity in the economy (unemployed workers,
unused machines etc…) then an increase in aggregate demand
will not cause demand pull inflation.
We know increases in aggregate demand are caused by an
increase to any of the following: C + G + I + (X - M)
However economists believe that one of the main causes of
inflation is increasing the money supply too much.
The USA gave 3 stimulus checks to all of its citizens...
● $1,200 in April 2020
● $600 in December 2020/January 2021
● $1,400 in March 2021
The coronavirus caused a huge shock to the global economy,
with shortages in raw materials, rises in unemployment etc…
a) Why do you think we are experiencing a large rise in
inflation across the world?
b) Draw a diagram to represent your answer to part a
c) Do you think inflation will continue to rise?
Recap
Cost-push inflation is when business respond to rising production
costs by increasing the prices of their goods or services.

Demand-Pull inflation occurs when we have a rapid increase

in aggregate demand, the economy is growing too fast.
Consequences of Inflation - Money Value
A main consequence of inflation is that the value of money
decreases.
This brings down people’s real net worth, their money is no
longer worth as much.
Hyperinflation (classed as above 50%) - People may also lose
trust in the currency and stop using it all together.
Consequences of Inflation - Redistribute incomes
People with fixed incomes (low bargaining power) lose out
whilst those who can argue for a better wage gain.
People who are borrowing money also gain, the value of their
debt is decreased.
People who are saving money lose out.
Consequences of Inflation - Effects on firms
Firms generally lose out due to inflation.
They have to employ extra people to estimate future costs.
Menu costs - costs of changing menus/signs/websites etc
Shoe-leather costs - Money received is losing its value
Consequences of Inflation - Other
Inflation causes uncertainty - make it difficult to plan ahead
Can harm balance of payments - rises in product prices make
goods uncompetitive internationally.
Fiscal drag - Governments may be slow to adjust tax brackets,
leading people to pay more tax
Beneficial Effects of Inflation

Inflation may encourage firms to expand. Low and stable

demand-pull inflation may cause optimism
Reduces household debt
Can prevent redundancies (workers losing their jobs) - they
may accept no increase in pay
d) Mongolia’s inflation rate is around 8%, what consequences do
you think will have the biggest impact in the country?
Policies to control inflation
For demand-pull inflation, contractionary fiscal and monetary policies
should be used to try and reduce aggregate demand.
For cost-push inflation, policies that improve the supply side of the
economy are often targeted. These may be costly and take a long time to
come into effect.
Cost-push inflation can be affected by events happening around the world
which are often unavoidable.
Deflation
If deflation comes from an increase in aggregate supply then this is not a
problem, workers can enjoy more goods and services and the country
can be more competitive internationally.
If deflation comes from a reduction in aggregate demand then this is
considered harmful. This can cause a downward economic spiral, with
consumers waiting to purchase goods as they believe they will be
cheaper in the future.