Tutorial 4: Section 3 ¬ Essay Questions

1. Define inflation and show it is measured. (4 marks)

Inflation is a persistent rising general level of prices.
Rate of inflation is calculated using consumer price index (CPI), compiled by the Bureau
of Labor Statistic (BLS)/ Department of Statistics Malaysia.
Inflation = [(CPI y2 – CPI y1)/CPI y1] x 100

Example:
The CPI in the nation of Montrose was 220 in 2016 and 200 in 2015. What is the rate of
inflation between 2015 and 2016?
Inflation rate = [(CPI y2 – CPI y1)/ CPI y1] x 100
= [(220 – 200)/200] x 100
= 10%
The rate of inflation between 2015 and 2016 in Montrose was 10%.

2. (a) Briefly describe the Rule of 70. (3 marks)

To calculate how long it would take for a given rate of inflation to double.
70 is divided by a given annual rate of inflation.
Example:
If annual rate of inflation is 3%, the price level will take about 23 years (= 70/3) to
double.

(b) Who is hurt by anticipated inflation? Describe any TWO (2) examples. (5 marks)
Fixed income receiver, savers and lender hurt by anticipated inflation. It
redistributed Real income away from them and towards others.
Fixed income receivers – people whose income are fixed see their real incomes fall
when inflation occurs.
Savers – value of savings decline if the rate of inflation exceeds the rate of interest.
An agent that is not spending some of their income usually if money is saved it is put
in some sort of interest-earning assets like a savings account or a bond or purchasing
some other financial assets such as stocks and bonds.
3. Identify any TWO (2) groups of people who are hurt by inflation and any TWO (2)
groups of people who benefit from inflation. (4
marks)
Two groups of people who are hurt by inflation are fixed income receivers and savers.
While two groups of people who is benefit from inflation are flexible-income receivers
and cost of living adjustment (COLAs).

4. Distinguish between demand-pull inflation and cost-push inflation. (5 marks)

Demand-pull inflation Cost-push inflation

Cause by an excess of total spending
beyond the economy’s capacity to
produce.
When additional supply is unavailable,
sellers raise their prices.
Cause by rising per-unit production costs.
It also known as supply-side inflation.
Sources that cause rising per-unit
production costs:
(a) (Adverse) Supply shocks: abrupt
increases in cost of raw material
drive up per-unit production costs
and thus product prices. For
example, the oil crisis in 1973 –
1974 and 1979 – 1980.
(b) Wage-push as a result of union
strength. Costs increase due to
increase in wages.

5. Briefly explain the following concepts:

(i) Consumer Price Index (CPI); (2 marks)
CPI is a widely cited index number for the price level; the weighted average of
prices of a specific set of goods and services purchased by a typical household.
 (ii) Base year. (2 marks)
Base year is the year chosen as a point of reference or basis of comparison for
prices in other years, a benchmark year.

6. Based on the data below:

Total expenditure in year 2012 RM750 billion

Total expenditure in year 2005 RM250 billion

(i) Calculate the Consumer Price Index (CPI) in 2012 assuming 2005 is the base
year.
(4 marks)
CPI in year 2012 = (Total RM expenditure on market basket in current year/ Total
RM expenditure on market basket in base year) x 100
= RM (750/250) billion x 100
= 300

(ii) Calculate the inflation rate for 2013, assuming the Consumer Price Index for
that year is 330. (4 marks)
CPI 2013 = 330
Inflation rate for 2013 = [(CPI later year – CPI earlier year)/ CPI earlier year] x 100
= [(330 – 300)/300] x 100
= 10%