Inflation

IFY
Economics
Week 20
L2 to 3
Inflation
OBJECTIVES
• Define inflation • Causes of Inflation: Internal or
• How inflation is measured and External
problem with measurement: RPI v • Causes of Inflation: Demand Pull,
CPI Cost Push, Excess Money Supply*
• The pattern of inflation in the UK in
recent years • *Understand using the Fisher formula
• The effects of inflation (Quantity Theory of Money)
• Using Index values - % change
INFLATION
Introduction to Inflation
Inflation is a sustained increase in the cost of living or the general
price level leading to a fall in the purchasing power of money
• The rate of inflation is measured by the annual percentage change in consumer

prices
• The UK government has set an inflation target of 2% using the consumer prices
index (CPI)
• It is the job of the Bank of England (BoE) to set monetary policy interest rates so
that inflationary pressures are controlled and the inflation target is reached
• A fall in inflation is not the same as a fall in prices! Only when there is deflation
will the general price level fall
Inflation – Some Key Terms
Defining Inflation
ØA sustained increase in the general level of prices in an economy
over a given time period
Inflation – a persistent
ØInflation figures released monthly increase in the average
price level in the economy
ØWe can also use the annual rate of inflation usually measured with the
CPI (Consumer Price
Index)
Inflation is a sustained increase in the

cost of living or the general price level
leading to a fall in the purchasing
power of money
MEASURES
Measuring Inflation
We will learn about two measures of inflation:
The Consumer Price Index (CPI)
This measure is used both in the UK and in the Eurozone
The Retail Price Index (RPI)
This is an older measure of inflation
The Consumer Price Index (CPI) measures changes in the prices of consumer goods bought
in the UK
Living costs & food Survey – surveys prices of 720 goods and services
Survey of household expenditure patterns
Creates a weighted price index to reflect the effect of price increases of different goods
on households
E.g. petrol price changes more significant than price of newspaper changes
The CPI is the headline measure of inflation
Internationally comparable
Produces a more stable headline rate than other measures
Measuring Inflation - The
Consumer Price Index (CPI)
ØThe CPI is a weighted price index used
to measure the change in the prices of a
typical basket of goods and services
ØThe contents of the basket are changed
each year
What goods & services do you think
ØIn the UK they use information from might have been added during the last
the Family expenditure Survey few years?
ØChanges in weighting reflects changes
in spending behaviour (the more that is Family Expenditure Survey: a
spent the higher the weighting)
representative monthly survey
ØIn 2008 fruit smoothies, muffins and of UK household expenditure
USBs were included in the basket used to derive changes in the
ØMicrowaves, 35mm camera film and CD CPI
singles were removed
Source: ONS
Measuring Inflation
We will learn about two measures of inflation:
The Consumer Price Index (CPI)
This measure is used both in the UK and in the Eurozone
The Retail Price Index (RPI)
This is an older measure of inflation
First of all, the RPI is similar to the CPI in that it surveys a basket of
goods and uses weighted averages
… but … there are some important differences
The RPI, unlike the CPI, includes Council Tax, mortgage interest
payments and other housing costs
Can produce a more volatile inflation figure
Excludes spending of pensioners and highest income household
Measurement Problems
Measures of inflation in the UK economy are much more sophisticated than
decades ago but we still have some problems…
ØChanges in quality
Ø Price changes that are measured do not take into account changing
quality of the product e.g. electronic goods
ØChanges in the pattern of expenditure
Ø New products are always coming onto the market and the weights used
for the CPI may lag behind what consumers are actually purchasing
ØDifferent income groups experience different inflation rates
Ø People on lower incomes much more vulnerable to changes in food and
energy prices
Ø Why do you think this is?
TARGETS
Target rate of Inflation
ØThe target rate of inflation in the UK is 2.0%
ØThis target is decided by the UK government
ØThe Bank of England has responsibility for managing
monetary policy in meeting the inflation target
ØSymmetric target, so 1.0% deviation either way
ØDown to 1.0% is acceptable, as is up to 3.0%
Øi.e. deflation is also considered a risk
ØEUROZONE target is 2% or below
ØAsymmetric target i.e. below is acceptable, not
above
ØCHINA target is around 3%
ØSlightly higher, suggests higher priority given to
short-run AD-led growth
UK inflation in recent years
Value of £1 from 1980 to 2020
According to the Office for National Statistics composite price
index, prices in 2020 are 331.64% higher than average prices
since 1980. The British pound experienced an average inflation
rate of 3.72% per year during this period, meaning the real value
of a pound decreased.
BENEFITS AND COSTS
OF INFLATION
The benefits of low inflation
A low and stable rate of inflation provides a number of benefits:
• Avoids the problems of high and unstable inflation

• Enables businesses to forward plan with confidence as they can accurately judge:
• Wage rates
• Raw material costs
• Consumer prices
• Rates of return to investment
• Consumers and workers have confidence in future spending plans if there is

relative price stability
• Better industrial relations as Trade Unions are less likely to take industrial action
over pay rises
Deflation
Deflation is a sustained fall in the price level in an economy over a given time
period
… or… negative inflation. Deflation – a persistent fall
in the average price level in
Tends to occur due to: the economy usually
measured with the CPI
A prolonged period of falling AD (Consumer Price Index)
Lack of consumer & investor confidence.
Consumers delay purchasing decisions as they expect prices fall – this is known
as deflationary expectations.
Similarly, firms delay investment decisions due to:
Low / delayed consumer spending
Expectations that the cost of capital and labour will fall, delaying
investment and employment decisions.
Deflation is harmful to an economy as it perpetuates low economic growth.
Deflation https://www.youtube.com/watch?v=qlj7tXMRuyM
• Japan has a problem with deflation

• Banks collapsed due to bad debts and bad investments in their own stock market
• People built up precautionary savings in case they lost their jobs
• This depressed consumption and AD
• Interest rates were cut to 0.25% but it didn’t work
• The damage had been done
• Consumer and business confidence crumbled with people and firms reluctant to spend
B13 to here end of L2
ØDon’t confuse deflation
(L3: watch video and move
with a falling rate of inflation on)
(this is called disinflation)
https://www.investopedia.com/articles/economics/08/japan-
1990s-credit-crunch-liquidity-trap.asp
Do you understand?
ØOver which period of time did Japan experience
a) Inflation
b) Disinflation
c) Deflation
(a) (b)
(c)
(d)
COSTS OF INFLATION
Costs (negative effects) of inflation
These are the main costs of inflation, we will explore each of these in turn:
• Shoe leather costs, Menu costs, Psychological costs
• Redistribution of income, Reduces real value of savings
• Lower economic growth, higher unemployment, lower investment
• Balance of Payments deficit

Unemployment and Economic Growth
ØEconomists argue that persistent high inflation creates unemployment
and lowers growth
ØInflation increases the costs of production and creates uncertainty
ØThis lowers the profitability of investment and may make businesses less
likely to take risks associated with investment projects
ØLower investment results in less long term employment and long term
growth
Balance of Payments / International Competitiveness
ØThe Balance of Payments current a/c is also affected
ØIf inflation rises faster in the UK than in other countries,

but the value of the pound does not adjust downwards
on foreign currency markets, then exports will become
less competitive and imports more competitive
ØThis will result in a trade deficit on the Balance of

Payments current a/c
Redistribution Costs: Income
• Inflation can redistribute income and wealth between households, firms and the
state.
• Anyone on a fixed income will suffer:
• Private pensions
• Welfare benefits (in context of benefits cap & freezes)
• Public sector pay freeze
• Private sector workers who aren’t able to negotiate increases in line with
inflation will suffer falls in their real income
Redistribution Costs: Savings
• Reduction of real value of savings
• If returns to savings (interest rates) are 2%
• … but the rate of inflation is 5%...
• What is happening to the value of your savings, in real terms?
• Which group of people is this likely to have the greatest impact on?
• Fiscal drag
• This is where personal allowances (amount you can earn before paying tax) or
taxation bands increase at a slower rate than the rate of inflation than wages.
£0 0% £12,570 20% £50,000 40% £150,000
• Hence, the effect of inflation is to reduce disposable income by dragging people into
higher tax bands https://moneyweek.com/investments/investment-strategy/too-embarrassed-
to-ask/602851/too-embarrassed-to-ask-fiscal-drag
Shoe leather costs
• If prices are stable, consumers and firms have some knowledge of what is
a fair price for a product.
• At times of rising prices, consumers and firms will be less clear about what
is a reasonable price.
• This will lead to more shopping around with a time cost.
Menu costs
Ø All businesses will have to change all of their price tags and calculate new
price lists.
Ø Even more costly are changes to fixed capital, such as vending machines
and parking meters.
Psychological costs
• People feel worse off if inflation is high. This may be the case even
if incomes are also rising.
Economic Costs of Inflation
• The economic costs of inflation depend on
• (i) The degree of inflation
• More costly when inflation is high and variable
• E.g. UK from the mid 1970s – to the early 1990s
• (ii) Whether inflation is

• Correctly anticipated by consumers and producers
• Unanticipated – i.e. expectations of inflation turn out to be wrong
• (iii) Whether inflation in one country is higher than in other countries with
whom trade takes place
• (iv) Whether the nominal exchange rate adjusts to restore lost price and cost
competitiveness for exporters
HYPERINFLATION
B19 here end L3

Hyperinflation
Extremely rapid, out of control inflation.
There is no precise numerical definition to hyperinflation,
but often in 10’s and 100’s of % points per day!
https://www.youtube.com/watch?v=78-BlZXm7wA
https://www.cato.org/sites/cato.org/files/pubs/pdf/hanke-krus-hyperinflation-table.pdf
Hyperinflation – Germany 1923
A simple example of hyperinflation:
Inflation %
The price of a loaf of bread
January 1922: 3.5 Marks
January 1923: 250 Marks
November 1923: 200,000,000 Marks

•Germany was already suffering from high levels of inflation due to the effects of the war
and the increasing government debt.
•‘Passive resistance’ meant that whilst the workers were on strike fewer industrial goods
were being produced, which weakened the economy still further.
•In order to pay the striking workers the government simply printed more money. This flood
of money led to hyperinflation as the more money was printed, the more prices rose. Prices
ran out of control.
•By autumn 1923 it cost more to print a note than the note was worth.
•During the crisis, workers were often paid twice per day because prices rose so fast their
wages were virtually worthless by lunchtime.
Hyperinflation winners:
• Borrowers, such as businessmen,
landowners and those with mortgages,
found they were able to pay back their
loans easily with worthless money.
• People on wages were relatively safe, Hyperinflation losers:
because they renegotiated their wages • People on fixed incomes, like students,
every day. However, even their wages pensioners or the sick, found their
eventually failed to keep up with incomes did not keep up with prices.
prices. • People with savings and those who had
• Farmers coped well, since their lent money, for example to the
products remained in demand and government, were the most badly hit as
they received more money for them as their money became worthless.
prices spiralled.
Inflation
Week 20
L3-4
B23 to here end L3
Using index numbers
Using index numbers and weightings
Category Index for Weight Index for Index for Weight Index for year
2020 2020 times year 2021 2021 times
weight weight
Housing 120 0.4
Foodstuffs 105 0.2
Travel 120 0.2
Clothing 120 0.1
Entertainment 125 0.1
Totals 1
Using index numbers with weightings

• When we bring several indices together in a basket we have to give each one a weighting
• The weighting will depend on the proportion of income that is spent on that good
• If we take this example on average 40% of income is spent on housing so it gets a weighting of 0.4
• To work out the weighted index you just multiply the index by the weight
2020 2020 times year 2021 2021 times
weight weight
Housing 120 0.4 130 0.4
Foodstuffs 105 0.2 105 0.2
Travel 120 0.2 125 0.2
Clothing 120 0.1 110 0.1
Entertainment 125 0.1 130 0.1
Totals 1 1

2020 2020 times year 2021 2021 times
weight weight
Housing 120 0.4 48 130 0.4
Foodstuffs 105 0.2 11 105 0.2
Travel 120 0.2 24 125 0.2
Clothing 120 0.1 12 110 0.1
Entertainment 125 0.1 12.5 130 0.1
Totals 1 1

2020 2020 times year 2021 2021 times
weight weight
Housing 120 0.4 48 130 0.4
Foodstuffs 105 0.2 11 105 0.2
Travel 120 0.2 24 125 0.2
Clothing 120 0.1 12 110 0.1
Entertainment 125 0.1 12.5 130 0.1
Totals 1 107.5 1
2020 2020 times year 2021 2021 times
weight weight
Housing 120 0.4 48 130 0.4 52
Foodstuffs 105 0.2 11 105 0.2 11
Travel 120 0.2 24 125 0.2 25
Clothing 120 0.1 12 110 0.1 11
Entertainment 125 0.1 12.5 130 0.1 13
Totals 1 107.5 1 112

2020 2020 times year 2021 2021 times
weight weight
Housing 120 0.4 48 130 0.4 52
Foodstuffs 105 0.2 11 105 0.2 11
Travel 120 0.2 24 125 0.2 25
Clothing 120 0.1 12 110 0.1 11
Entertainment 125 0.1 12.5 130 0.1 13
Totals 1 107.5 1 112
% change from 2020 to 2021?

2020 2020 times year 2021 2021 times
weight weight
Housing 120 0.4 48 130 0.4 52
Foodstuffs 105 0.2 11 105 0.2 11
Travel 120 0.2 24 125 0.2 25
Clothing 120 0.1 12 110 0.1 11
Entertainment 125 0.1 12.5 130 0.1 13
Totals 1 107.5 1 112

% change from = ((112 – 107.5) / 107.5) x 100
2020 to 2021?
2020 2020 times year 2021 2021 times
weight weight
Housing 120 0.4 48 130 0.4 52
Foodstuffs 105 0.2 11 105 0.2 11
Travel 120 0.2 24 125 0.2 25
Clothing 120 0.1 12 110 0.1 11
Entertainment 125 0.1 12.5 130 0.1 13
Totals 1 107.5 1 112

% change from = ((112 – 107.5) / 107.5) x 100
2020 to 2021? = 4.19%
Learning Objectives:
§ Index Numbers – IL task
§ Index Numbers – using weightings
§ Hyperinflation – Germany 1923
§ Inflation Data Task – Use of Index Numbers
§ The Phillips Curve
§ MCQ’s and Review Essay Types

Learning Objectives
Causes of Inflation: Internal or External
Causes of Inflation: Demand Pull, Cost Push, Excess Money Supply*
*Understand using the Fisher formula (Quantity Theory of Money)
Using Index values - % change

Related Reading
OCR A Level Economics 4th Edition

Ø Chapter 25 Inflation
Ø Chapter 37 Money and interest rates
Causes of inflation: Internal or External
Causes of inflation: Internal or External
• Inflation comes from several sources:
Domestic economy
• Price strategies of leading food retailers based on the strength of demand
or competitive pressures
• A rise in VAT causes firm’s production costs to go up and these being

passed onto the consumer
• External sources
• E.g. An increase in the price of crude oil or other widely used imported
commodities, foodstuffs and beverages
• A changes in exchange rates

• E.g. A falling GBP value against the Euro might cause higher import
prices
Three Causes of inflation
Three Causes of inflation
• There are 3 main types of inflation:
• Demand pull inflation
• Cost push inflation
• Inflation due to Excess monetary growth

1. Demand Pull Inflation
• As the name suggests demand pull inflation is

caused by an increase in demand (AD)
• It is most likely to occur when there is little spare

capacity in the economy
• Remember that AD increases when one or more of the

AD components increases (except M).
• AD = C + I + G + X - M
y
Examples of Demand-Pull Inflation
• Occurred in the UK during the late 1980’s
• Typically characterised by high GDP growth (a boom) followed by

a recession (bust)
• The following recession of 1990-92 saw unemployment reach

3m
2. Cost push inflation:
This occurs as a result of an increase in the costs of production
• Any increase in a firm’s costs shifts the supply curve left
• If the cost of an input such as oil increases, that affects the

costs of many businesses in the economy and so the SRAS will
shift left
• What then causes production costs to go up and force firms

to raise their prices to maintain profit margins?
• A rise in costs of imported raw materials (e.g. by a fall in
the value of the country’s currency)
• Rising labour costs
• Higher indirect taxes
• Wage-price spirals
This shows two periods of cost-push inflation in the UK – 2008
and 2011.
These periods of cost-push inflation proved relatively temporary

because the economy was in recession.
Many cost-push factors like rising energy prices, higher taxes,

and the effect of devaluation may prove temporary.
Therefore, Central Banks may tolerate a higher inflation rate if it

is caused by cost-push factors.
In early 2008, the UK had a high period of inflation (5%) due to

rising oil and food prices. Central banks kept interest rates high,
but this pushed the economy into recession. Arguably, interest
rates should have been lower and less importance attached to
reducing cost-push inflation.
Perhaps learning its lesson, in 2011, CPI inflation reached 5%,

but the Bank of England kept base rates at 0.5%.
This showed the Bank of England felt by this point that

underlying inflationary pressures were low.
Cost-Push Inflation
• Occurred in the UK during the 1970’s
• The 1973 Oil Crisis saw oil prices rapidly increase 3-fold
• Hence, increased transportation costs, transmitting through

the supply chain, caused cost-push inflation throughout the
economy
• The situation was exacerbated by the efforts of trade unions

(somewhat understandably) demanding wage increases in
excess of inflation due to uncertainty
• The result was further cost-push inflation due to wage-

price spirals
Hyperinflation is a term to describe rapid, excessive, and out-of-control general price
increases in an economy. Hyperinflation occurs when the inflation rate exceeds 50% for a
period of a month. Example: Zimbabwe, 2007 to 2008, prices doubled every 24.7hours.
3. Excess monetary growth
• Monetarists (a branch of new classical
economists) believe that inflation is caused by
excessive increases in money supply
• If there is more money in the economy there will

be higher spending and AD will increase
• Because this is a new classical theory we draw the

LRAS vertical
Milton Friedman (1912-2006) was
a Monetarist who believed that
government intervention always
causes more harm than good
Fisher Formula – The Quantity Theory of Money
The transactions version of the quantity theory of money was
provided by the American economist Irving Fisher in his book - The
Purchasing Power of Money (1911).
According to Fisher, “Other things remaining unchanged (Cet. Par.), as

the quantity of money in circulation increases, the price level
also increases in direct proportion and the value of money decreases
and vice versa.”
Fisher formula: MV = PT
M = Money Supply P = Average Price Level
V = Velocity of Circulation (The T = Volume of Transactions of Goods

number of times money changes hands. and Services
The higher the velocity of money, the
quicker the spending in the economy).
Money is demanded not for its own sake (i.e., for

hoarding it), but for transaction purposes.
The demand for money is equal to the total market

value of all goods and services transacted.
So, MV refers to the total volume of money in
circulation during a period of time. It is obtained by multiplying total amount of things
(T) by average price level (P).
MV = PT
=
The supply of money or the total
value of money expenditures in
The demand for money or the
total value of all items
all transactions transacted.
MV = P
T
P = MV
T
Money velocity in the United Kingdom is currently less than 1 which means that money
being printed (even notionally) isn’t even circulating once.
It has fallen significantly this century, it has started increasing as GDP growth is accelerating
and Money Supply growth is decelerating.
M4 Money Stock or Money Supply for the United Kingdom is bigger than the GDP of the
United Kingdom and stands at a record of £2.85 trillion (at the end of September 2018).
And so, Monetarists argue that if the Money Supply rises faster than
the rate of growth of national income, then there will be inflation.
If the money supply increases in line with real output then there will
be no inflation.
MCQ Practice
MCQ Practice 1
MCQ Practice 1
MCQ Practice 2
MCQ Practice 2
MCQ Practice 3
MCQ Practice 3
MCQ Practice 4
MCQ Practice 4
Essay Practice
a) Identify and explain the effects of inflation on an individual and
the economy. [10 marks]
Essay Practice
a) Identify and explain the effects of inflation on an individual
and the economy. [10 marks]
To access the full range of marks, candidates must consider both
aspects of the question.
Impacts on an individual may Impacts on the economy may
include: include:
Shoe leather costs Menu costs

Reduced value of savings Shoe leather costs
Wage values Reduced international
Wage bargaining competitiveness
Asset prices Impact of counter inflationary
Uncertainty policy
Links with economic cycle
MCQ Practice 1
MCQ Practice 1
= ((110 – 105) / 105) * 100
Essay Questions (10 marks)
Year V Question
1 2011-12 2 Identify and explain the effects of inflation on an individual and the economy.
2 2014-15 3 With the use of a diagram, explain the likely effect of an increase in inflation on an economy.
Explain, using diagrams where appropriate, one way inflation may be caused in an economy and
3 2015-16 1
analyse two costs of inflation to an economy.
4 2012-13 2 Describe, with examples, the different causes of inflation in an economy.
5 2013-14 1 Explain the different causes of inflation.
6 2014-15 4 Explain carefully how inflation might occur in an economy.

Analyse the main causes of inflation in an economy and briefly outline the pattern of inflation in the
7 2015-16 3
UK in recent years.
8 2016-17 1 Describe the main causes of inflation and analyse the main effects of high inflation.
9 2017-18 4 Analyse AND illustrate with a diagram the different causes of inflation in an economy.
Year V Question
The Fisher Equation states that increases in the money supply directly impacts upon the rate of inflation
2011-12 2 in an economy. To what extent do you agree that controlling the money supply is the best way to control
1 inflation?
2014-15 3 Evaluate the view that fiscal policy is the most effective way for a government to reduce inflation.
2
3 2014-15 4 Evaluate the extent to which monetary policy is effective in combating inflation in an economy.
Evaluate the extent to which fiscal policy is effective in combating the effects of rising inflation in an
2015-16 1
4 economy.
The Quantity Theory of Money shows that the money supply has a direct and proportional impact on the
2015-16 3 price level in an economy. To what extent do you agree that control of the money supply is the most
effective method of controlling inflation in an economy?
5
2016-17 1 Evaluate the view that high inflation is always a sign of poor economic performance.
6
Discuss the view that the control of inflation should be a government’s primary macro-economic
2012-13 2
7 objective.
2013-14 1 Evaluate the extent to which low inflation should be the government’s main macroeconomic priority.
8
Evaluate the view that the control of inflation should be a government’s primary macro-economic
2017-18 4
9 objective.
Inflation
Week 20
L3 to 4
Using index numbers
Using index numbers Year Index
• This table shows the made up index of house prices
2017 100.0
• 2017 is the base year
2018 108.4
• Between 2017 and 2018, the % change in house prices is EASY to
calculate, because 2017 is the BASE YEAR. 2019 120.0
• The increase is 108.4 – 100, which gives an increase of 8.4% in house prices.
• Between 2017 and 2019, the % change is also EASY as again, we are using the BASE YEAR to
start from. There is an increase of 120 – 100 = 20%.
• But between 2018 and 2019, we need to take more care. It is not 120 – 108.4 = 11.6% !
• It is ( 120 - 108.4 ) / 108.4 x 100 = 10.7%

Using index numbers
Category Index for Weight Index for Index for year Weight Index for year
year X year X X +1 (X+1) times
times weight
weight
Housing 120 0.4 48 130 0.4 52
Foodstuffs 105 0.2 11 105 0.2 11

Travel 120 0.2 24 125 0.2 25
Clothing 120 0.1 12 110 0.1 11
Entertainment 125 0.1 12.5 130 0.1 13
Totals 107.5 1 112

Using index numbers
• To find out the rate of inflation you need to do the following sum
• New index – old index divided by old index
• In this case it would be Index for (X +1) minus Index for X divided by Index for X
• Multiply by 100 to get the % inflation rate
• (112 – 107.5) / 107.5 = 4.2%
Category Index Weig Index Index for Weigh Index for
for ht for year year X +1 t year (X+1)
year X X times times
weight weight
Housing 120 0.4 48 130 0.4 52
Foodstuffs 105 0.2 11 105 0.2 11
Travel 120 0.2 24 125 0.2 25
Clothing 120 0.1 12 110 0.1 11
Entertainment 125 0.1 12.5 130 0.1 13
Totals 107.5 1 112

Data Response Question (1415 v1 A21-25)
Year V Question
1 2011-12 2 Identify and explain the effects of inflation on an individual and the economy.
2 2014-15 3 With the use of a diagram, explain the likely effect of an increase in inflation on an economy.
Explain, using diagrams where appropriate, one way inflation may be caused in an economy and
3 2015-16 1
analyse two costs of inflation to an economy.
4 2012-13 2 Describe, with examples, the different causes of inflation in an economy.
5 2013-14 1 Explain the different causes of inflation.
6 2014-15 4 Explain carefully how inflation might occur in an economy.

Analyse the main causes of inflation in an economy and briefly outline the pattern of inflation in the
7 2015-16 3
UK in recent years.
8 2016-17 1 Describe the main causes of inflation and analyse the main effects of high inflation.
9 2017-18 4 Analyse AND illustrate with a diagram the different causes of inflation in an economy.
Year V Question
The Fisher Equation states that increases in the money supply directly impacts upon the rate of inflation
2011-12 2 in an economy. To what extent do you agree that controlling the money supply is the best way to control
1 inflation?
2014-15 3 Evaluate the view that fiscal policy is the most effective way for a government to reduce inflation.
2
3 2014-15 4 Evaluate the extent to which monetary policy is effective in combating inflation in an economy.
Evaluate the extent to which fiscal policy is effective in combating the effects of rising inflation in an
2015-16 1
4 economy.
The Quantity Theory of Money shows that the money supply has a direct and proportional impact on the
2015-16 3 price level in an economy. To what extent do you agree that control of the money supply is the most
effective method of controlling inflation in an economy?
5
2016-17 1 Evaluate the view that high inflation is always a sign of poor economic performance.
6
Discuss the view that the control of inflation should be a government’s primary macro-economic
2012-13 2
7 objective.
2013-14 1 Evaluate the extent to which low inflation should be the government’s main macroeconomic priority.
8
Evaluate the view that the control of inflation should be a government’s primary macro-economic
2017-18 4
9 objective.
The Phillips Curve
The Phillips curve
…is an economic concept developed by A. W. Phillips stating that inflation and
unemployment have a stable and inverse relationship. The theory claims that with
economic growth comes inflation, which in turn should lead to more jobs and less
unemployment.
Alban William Housego "A. W." "Bill" Phillips, MBE (18 November 1914 – 4 March
1975)[1] was a New Zealand economist who spent most of his academic career as a
professor of economics at the London School of Economics (LSE). His best-known
contribution to economics is the Phillips curve, which he first described in 1958. He
also designed and built the MONIAC hydraulic economics computer in 1949.
https://www.youtube.com/watch?v=rAZavOcEnLg
The Phillips curve
Rate of
Change of
Wages
0
Rate of
Unemployment
At A, the LR equilibrium shows
The Phillips curve the labour market in equilibrium,
SRPC2 SRPC3
with inflation at 2% and the
SRPC1 unemployment rate at 6% (NRU).
LRPC
Price
Level At this equilibrium, people expect
prices to rise at a rate of 2%.
But the government is unhappy with
unemployment being at 6%. It attempts to
2 reduce it (expansionary FP and MP).
A
0
6 Rate of
Unemployment
The Phillips curve Workers experience nominal wages
rising by 6%, but believe inflation is 2%.
SRPC2 SRPC3 They believe their real wage has risen
SRPC1
(by 4%).
LRPC
Price
Level More workers are attracted to work.
We move to B.
Short run unemployment falls to 4%,

6 B but inflation in fact rises to 6%.
2 A
0
4 6 Rate of
Unemployment
The Phillips curve Workers realise that inflation is in
fact now 6%. Real wages have not
SRPC1
SRPC2 SRPC3 risen.
LRPC
Price
Some workers leave the market
Level
and unemployment returns to
6%.
6 B C
We are at C. Unemployment is at
2 A 6% and inflation is at 6%.
0
4 6 Rate of
Unemployment
If the government tries again to reduce
The Phillips curve unemployment using AD policies, the same will
happen again.
SRPC2 SRPC3
SRPC1
Workers are attracted to the market believing
LRPC
Price wages have risen again. Nominally they have.
Level We are at D.
10 D But inflation rises to 10%.

6 B C
Some workers return to being unemployed.
2 Unemployment is again 6%.
A
0
4 6 Rate of
Unemployment
The Phillips curve But inflation rises to 10%.
SRPC2 SRPC3 Some workers return to being unemployed.

SRPC1
LRPC Unemployment is again 6%.
Price
Level The economy reaches a new
LR equilibrium, with
10 D E
unemployment at 6% (the
6 natural rate) and inflation now
B C
at 10%.
2 A
0
4 6 Rate of
Unemployment
The Phillips curve
The natural rate of unemployment can therefore
only be decreased through supply side policies.
LRPC2 LRPC1
Price These, if successful, will shift the LRPC LEFT.
Level
(This is a RIGHT shift in LRAS and OUT shift of
PPF)
0
3 6 Rate of
Unemployment
The Phillips curve Why Different Economies Have Different NRU
Different benefit rates, trade union power,

labour market legislation, firms’ wage setting
LRPC2 LRPC1 practices.
Price
Level
0
3 6
Rate of
Unemployment
Learning Objectives: LL2
§ Index Numbers – IL task
§ Index Numbers – using weightings
§ Hyperinflation – Germany 1923
§ Inflation Data Task – Use of Index Numbers
§ The Phillips Curve
§ MCQ’s and Review Essay Types

MCQ Practice 1
MCQ Practice 1
MCQ Practice 2
MCQ Practice 2
MCQ Practice 3
MCQ Practice 3
MCQ Practice 4
MCQ Practice 4
Essay Practice
a) Identify and explain the effects of inflation on an individual
and the economy. [10 marks]
Essay Practice
a) Identify and explain the effects of inflation on an individual and
the economy. [10 marks]
To access the full range of marks, candidates must consider both
aspects of the question.
Impacts on an individual Impacts on the economy

may include: may include:
Shoe leather costs Menu costs

Reduced value of savings Shoe leather costs
Wage values Reduced international
Wage bargaining competitiveness
Asset prices Impact of counter
Uncertainty inflationary policy
Links with economic cycle
Inflation Data Task – Use of Index Numbers
Your task is to discover what is happening with the price level by using
the index values of CPI given:
Month: CPI Index: % Change: Description:
January 100
February 110
March 121
April 127.05
May 120.7
June 120.7
January 100 n/a n/a

February 110
March 121
April 127.05
May 120.7
June 120.7
January 100 n/a n/a

February 110 10%
March 121
April 127.05
May 120.7
June 120.7
January 100 n/a n/a

February 110 10% Inflation
March 121
April 127.05
May 120.7
June 120.7
January 100 n/a n/a

March 121 10%
April 127.05
May 120.7
June 120.7
January 100 n/a n/a

March 121 10% Constant Inflation
April 127.05
May 120.7
June 120.7
January 100 n/a n/a

April 127.05 5%
May 120.7
June 120.7
January 100 n/a n/a

April 127.05 5% Disinflation
May 120.7
June 120.7
January 100 n/a n/a

May 120.7 -5%
June 120.7
January 100 n/a n/a

May 120.7 -5% Deflation
June 120.7
January 100 n/a n/a

June 120.7 0%
January 100 n/a n/a

June 120.7 0% No inflation

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• The rate of inflation is measured by the annual percentage change in consumer

Inflation is a sustained increase in the

• Avoids the problems of high and unstable inflation

• Consumers and workers have confidence in future spending plans if there is

• Japan has a problem with deflation

• Shoe leather costs, Menu costs, Psychological costs

• Redistribution of income, Reduces real value of savings

• Lower economic growth, higher unemployment, lower investment

• Balance of Payments deficit

ØInflation increases the costs of production and creates uncertainty

ØIf inflation rises faster in the UK than in other countries,

ØThis will result in a trade deficit on the Balance of

• Anyone on a fixed income will suffer:

£0 0% £12,570 20% £50,000 40% £150,000

• (ii) Whether inflation is

B19 here end L3

The price of a loaf of bread

January 1922: 3.5 Marks

January 1923: 250 Marks

November 1923: 200,000,000 Marks

Using index numbers with weightings

Using index numbers with weightings

Using index numbers with weightings

Totals 1 107.5 1 112

Totals 1 107.5 1 112

% change from 2020 to 2021?

Totals 1 107.5 1 112

% change from 2020 to 2021?

Totals 1 107.5 1 112

% change from 2020 to 2021?

§ Index Numbers – using weightings

§ Hyperinflation – Germany 1923

§ Inflation Data Task – Use of Index Numbers

§ The Phillips Curve

§ MCQ’s and Review Essay Types

Causes of Inflation: Demand Pull, Cost Push, Excess Money Supply*

*Understand using the Fisher formula (Quantity Theory of Money)

Using Index values - % change

OCR A Level Economics 4th Edition

• A rise in VAT causes firm’s production costs to go up and these being

• A changes in exchange rates

• There are 3 main types of inflation:

• Demand pull inflation

• Cost push inflation

• Inflation due to Excess monetary growth

• As the name suggests demand pull inflation is

• It is most likely to occur when there is little spare

• Remember that AD increases when one or more of the

• Typically characterised by high GDP growth (a boom) followed by

• The following recession of 1990-92 saw unemployment reach

• Any increase in a firm’s costs shifts the supply curve left

• If the cost of an input such as oil increases, that affects the

• What then causes production costs to go up and force firms

These periods of cost-push inflation proved relatively temporary

Many cost-push factors like rising energy prices, higher taxes,

Therefore, Central Banks may tolerate a higher inflation rate if it

In early 2008, the UK had a high period of inflation (5%) due to