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context 2,  AS Econ Paper 2   - Q5, Q6 and Q7

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context 2,  AS Econ Paper 2   - Q5, Q6 and Q7

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go to page 14 and 15

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Gentle inflation is a spur to spend - because if you've got the money and you're not feeling gloomy, then you will spend today, because tomorrow prices might be a bit higher.

It is also a spur to borrow for investment, in a home if you are a household or in productive kit if you are a business, because if you think your earnings will at least rise in line with inflation, then the burden of your debt will diminish with passing years.

So moderate inflation tends to be associated with steady growth in national income - of the sort that should make us sustainably richer

That is why the government has set a target for the Bank of England of setting monetary conditions - through changes to the interest rate for lending to banks and via quantitative easing - to keep inflation at 2%, with a one percentage point margin of error on either side of 2%.

So with CPI inflation today announced at 0.5% for December - the joint lowest since records began in 1989 - the Bank of England has failed.

And for the first time ever it has failed because inflation is too low (it missed the target on the upside well over 30 times after 2007).

Now as I said yesterday, that failure is - arguably - good news, at least in the short term.

That is because what has been driving inflation lower has been a 10.5% fall in motor fuels over the past year and a 1.9% fall in food prices. And since we have to buy food and fuel, those reductions increase our spending power, they make our money go further - they are the equivalent of a lovely hefty tax cut (of the kind that the chancellor would love to give us but can't afford).

It is also worth pointing out that food and fuel prices are set - to a great extent - by global supply and demand, and cannot be influenced more than a bit by how cheap or expensive the Bank of England tries to make the pound.

But that doesn't mean falling prices can be blithely ignored.

There are fears that endemic falling prices, or Japanese-style deflation, could become long-lasting and intractable in the eurozone.

And right now we in the UK are likely to ship in disinflation or downward pressure on prices from the eurozone - because the European Central Bank's determination to make money as cheap as possible means that the pound will go much further when buying goods and services priced in euros.

The point is that annual inflation of 0.5% here is not much of a buffer against deflation. And we've already seen three consecutive months in the UK of deflation in clothing and footwear, and almost no inflation in furniture.

As I have been banging on about, if we became accustomed to prices falling as the new norm, we would spend less - in that delaying would always make our money go further. And then the economy would sclerotic and stagnant, and desperately difficult to reinvigorate.

Given the disinflationary impact of the UK's record debt burden (the sum of household, corporate, financial and government debt), it is not inconceivable that "good" low inflation could become "bad" deflation.

How grave is that danger? Well I am on my way to see the governor of the Bank of England to ask him just that.
UPDATE 11:55
I have just interviewed the governor of the Bank of England.

Mr Carney says he expects inflation to fall further, as petrol prices are reduced to catch up with the tumbling oil price.

But his current assessment is that the reduced food and energy prices are an economic stimulus - because, as I mentioned earlier, they boost our spending power.

He said that conditions in the eurozone were more deflationary than here, citing its much higher unemployment rate and stagnant wages.

That said Mr Carney said it was not impossible that the falls in energy and food prices could infect other sectors - such that growth-killing deflation could become a more clear and present danger.

The Bank had the tools to deal with that risk, he said, to nudge inflation back towards the 2% target.

Evasive action, if needed, would be by keeping interest rates at these record low levels for a bit longer, he said, rather than engaging in more money creation through quantitative easing.

He wanted to stress that the Bank still expected to "normalise" interest rates, or raise them gently, within the foreseeable future.

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Could 'good' low inflation become 'bad' deflation?

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Gentle inflation is a spur to spend - because if you've got the money and you're not feeling gloomy, then you will spend today, because tomorrow prices might be a bit higher.

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Death of Manufacturing & the Global Deflation

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A Japanese Lesson in Deflation for Europe

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As Europe slides towards deflation, Japan offers a window on how that cycle of falling prices, wages, spending an investment can affect an economy.

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Inflation | Finance & Capital Markets | Khan Academy

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Want to learn about the history of inflation? Watch our short video to find out more.

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Inflation has many important costs and consequences for both society and business

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hyperinflation sloman and garrat case study

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88 Inflation - consolidation exercise (1)

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deflation - why it is much scarier than inflation!

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a timely analysis of why deflation is a far more scary prospect thatn deflation.

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Some countries have experienced periods of deflation in recent years; perhaps the most well-known example was Japan during the late 1990s and in the current decade. In Japan, the root cause of deflation was slow growth and a high level of spare capacity that was driving prices lower.

Greece and a number of Euro Area countries are now experiencing price deflation as are countries such as Switzerland and Denmark

Why might deflation be damaging for an economy?

1. Holding back on spending: Consumers may postpone demand if they expect prices to fall in the future

2. Debts increase: The real value of debt rises with deflation and higher real debts can be a big drag on consumer confidence

3. The real cost of borrowing increases: Real interest rates will rise if nominal rates of interest do not fall in line with prices.

4. Lower profit margins: Lower prices can mean reduced revenues & profits for businesses - this can then lead to higher unemployment as firms seek to reduce costs by shedding labour.

5. Confidence and saving: Falling asset prices such as price deflation in the housing market hits personal sector wealth and confidence

6. Income distribution: Deflation leads to a redistribution of income from debtors to creditors - but debtors may then default on loans

7. Deflation can make exporters more competitive eventually - but this often comes at a cost i.e. higher unemployment in short term

What economic policies might be used to avoid a period of price deflation?
The main approach to avoiding deflation is to use macro-stimulus policies either by loosening monetary policy and/or fiscal policy
Low interest rates and quantitative easing

In some countries, policy interest rates have become negative e.g. Switzerland and Japan

Cheaper loans for businesses and households

Expanding the supply of credit in banking system

QE used by many central banks including BoE and European Bank

Fiscal stimulus measures

Higher government spending (e.g. capital projects)

A rise in government borrowing to inject demand into the circular flow

Lower direct taxes to increase disposable income and spending

Other measures to stimulate aggregate demand

Attempts to lower (devalue) the value of the exchange rate (perhaps via central bank intervention to sell their currency in the market)

Higher taxes on savings to encourage consumption

Relevant articles on the issue of deflation
(BBC, Jan 2015): Denmark, Deutschland and deflation: strange times for EU http://www.bbc.co.uk/news/business-31050192

(BBC Robert Peston, Jan 2015): Could 'good' low inflation become 'bad' deflation? http://www.bbc.co.uk/news/business-30795424

Deflation danger for the Euro? http://www.bbc.co.uk/programmes/p02g37r1

(BBC Robert Peston, Oct 2014) Why Germant won't fight price deflation http://www.bbc.co.uk/news/29649073

(Guardian, Jan 2015) Analysts fear financial crisis as Chinese deflation looms: http://www.theguardian.com/business/2015/jan/09/ch...

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Explaining Price Deflation - Causes, Effects and Policies | tutor2u Economics

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Some countries have experienced periods of deflation in recent years; perhaps the most well-known example was Japan during the late 1990s and in the current decade. In Japan, the root cause of deflation was slow growth and a high level of spare capacity that was driving prices lower.

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MCQ Revision Question - Inflation Targets

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​Here is an interesting A level multiple choice question about what is likely to happen to interest rates and the exchange rate if the central bank of a country with a floating exchange rate opts to lower their inflation target.

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Price Volatility and Buffer Stock Schemes

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MCQ Revision Question - Consumer Price Index

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Here is a question that asks students to make some percentage calculations to find out which country has had the lowest annual rate of inflation.

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video - starter

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Inflation - Explained | tutor2u Economics

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The Impact of rising house prices | tutor2u Economics

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The Halifax has calculated that the average rise in house prices in the UK was 10% for 2015. House price rises in the UK appear to be a double-edged sword - for those who own their own home a persistent rise in its price will give the impression that their wealth is increasing.

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How much are train fares set to rise?
What is the justification for such a price increase?
Have rail prices lagged or lead the CPI?
Does rail travel offer good value for money? (Why/Why not?)

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Train fares in Britain will go up by an average of 2.3% from 2 January, the rail industry has announced.

The increase covers both regulated fares, which includes season tickets, and unregulated fares, such as off-peak leisure tickets.

The rise in regulated fares had already been capped at July's Retail Prices Index inflation rate of 1.9%. Unregulated fares face no cap.

Campaigners said passengers would be disappointed by the increase.

"Passengers will now want to see the industry's investment deliver a more reliable day-to-day railway," said Anthony Smith, chief executive of the watchdog Transport Focus.

"The government should consider setting rail fare rises around the Consumer Prices Index instead to bring rail fares into line with other recognised measures of inflation."

Lizzie Green, a London commuter, said: "Given that the trains are so irregular and the delays are so often it seems like a bit of a cheeky increase."

Some unregulated fares are likely to rise by considerably more than 2.3%.

That far outstrips the inflation rate, which is currently running at 0.9%, as measured by the Consumer Prices Index.

Analysis: Richard Westcott, BBC transport correspondent

The pace of fare increases has slowed a little in recent years, but it follows a decade's worth of steeper rises which began in 2004.

It's all because successive governments have changed the way they split the bill for running the service, so that passengers pay more and other taxpayers pay less.

About 70% of the total network cost is met from ticket sales now. It used to be about 50%.

Ministers are spending record amounts upgrading the service, which is creaking under huge demand for train travel that no-one saw coming.

But it hasn't stopped punctuality levels falling well below target.

The Rail Delivery Group, which represents train operators and Network Rail, said the industry was working to simplify fares and improve services.

"We understand how passengers feel when fares go up, and we know that in some places they haven't always got the service they pay for," said Paul Plummer, chief executive of the Rail Delivery Group.

"Around 97p in every pound passengers pay goes back into running and improving services."

The overall 2.3% increase covers fares in England and Wales and Scottish policy as expected at the moment. Northern Ireland is treated separately.

Authorities in Scotland can set their own fare increases.

A Scottish government spokeswoman said: "No final decision has been taken on next year's fares in Scotland and we are looking at options before the end of the year."

She added that the government would consider a fare freeze if it could "enable us to reduce costs to passengers while still delivering our ambitious infrastructure programme".

Compensation

Meanwhile, more than 84,000 passengers on Southern Rail are to receive compensation for the disruption they have experienced during 2016.

The government said the delays were caused by "Network Rail track failures, engineering works, unacceptably poor performance by the operator and the actions of the RMT union."

It has set aside £15m to pay commuters.

Season ticket holders will be able to claim a month's compensation, directly into their bank account.

To qualify, customers must have paid for at least 12 weeks of travel, between 24 April and 31 December 2016.

From 11 December passengers on Southern Rail will additionally be able to claim compensation if their train is more than 15 minutes late.

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Train fares in Britain will go up by an average of 2.3% from 2 January, the rail industry has announced. The increase covers both regulated fares, which includes season tickets, and unregulated fares, such as off-peak leisure tickets. The rise in regulated fares had already been capped at July's Retail Prices Index inflation rate of 1.9%.

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In a shop stacked to the ceiling with toys, Brenda Cleaver is searching for a very specific car. "I am looking for a modern road vehicle, and I am checking the price. Here it is. It hasn't changed," she says, comparing the price sticker on the toy car with the information on her handheld computer. She moves on in search of a snakes and ladders game.

Cleaver is one of hundreds of people across the UK who help collect thousands of prices each month to feed into a national basket that keeps track of the country's inflation rate. These field workers look for the same items in the same stores each month and send their prices to the Office for National Statistics (ONS) in Newport, Wales.

The exact dates for each month's price collection is kept secret to avoid risking a change in shop prices on that specific day.

Once complete, the collectors' reports are used by ONS number crunchers to price a 700-item shopping list that includes food such as sliced bread and other items ranging from hamsters to golf club fees and cinema tickets.

The idea is to measure how fast prices are rising or falling - now in sharper focus since the Brexit vote pushed down the pound and ended the UK's era of virtually zero inflation.

The latest rate, measured on the consumer price index (CPI), was the highest for two and a half years, at 1.6% and figures out on Tuesday are expected to show it pushed higher still in January to 1.9% as sterling's weakness continued to raise the cost of imports such as fuel and food ingredients. Policymakers at the Bank of England are under instruction from the government to try and keep inflation close to 2%.

This week's number, as in every month, will be based in part on 100,000 prices for about 520 items harvested by price collectors in 150 places. They are employed by market research firm TNS, which has the contract for price collection.

Cleaver has been tracking price changes since TNS first got the contract in 1994. She now supervises collectors for 17 areas across London and the south-east, training them and often accompaning them oto ensure they are sticking to the standards required.

"We are the foot soldiers. We are the people who go out and collect the same items each month," she says.

Inflation estimates are used to help set pay rises, benefits, rail fares, and also reflect the cost of living faced by households. The Bank of England tracks inflation to assess if it has set interest rates at the right level to stop prices soaring or sinking - known as deflation.

Cleaver moves on from Nuxley Toys in Gravesend to Elephant Music, where she seeks a beginner's acoustic guitar with a wooden body and neck.

The price collection is always done with the consent of retailers and Dennis Halberg, co-owner of the store, says: "It's something I am a little bit proud of that we've got a product in the prices measure".

Cleaver has found the guitar and is checking if the strings are nylon or steel. On her mini computer she points to last month's description and explains a price collector ideally tracks the same item. Changes in technology and fashion mean that it is not always possible to make exact comparisons, in which case the collectors will find a comparable item.

A jumper, for instance, would need to be a similar style, the same or similar material and similar quality. The collector makes a note for the ONS statisticians that it is not exactly the same item. There are also notes to show if something is in the sale, back at full price, temporarily out of stock or a new item altogether.

There is also a weight change indicator which the collectors may find themselves using more this year. This would show, for example, that a chocolate bar weighing 60g last month was 50g this month. If the price is the same and the weight has gone down, there has indeed been some inflation for that item, or what has become known as shrinkflation.

As imports have become more expensive, some manufacturers have deployed this shrinking tactic to absorb some of their higher costs. But it rarely goes unnoticed and when Toblerone spaced out its signature triangles last year it caused an uproar.

At the ONS, it never goes unnoticed, says consumer prices statistician Philip Gooding. "In any case where we are getting a change in quantity, we would adjust for it," he says.

Gooding and his colleagues complement the price collectors by gathering another 80,000 prices for 190 items over the telephone and internet, such as solicitor fees and mobile phone charges.

The ONS also updates the basket each year to reflect people's changing habits. In recent years, satnavs and frozen pizzas have come out, and music streaming services, headphones and craft beers have gone in. Last year e-cigarette stores were added to the price collectors' beat to complement the information already being collected from online retailers.

Statisticians also use "web scraping" where software collects prices from websites.

In her 22 years collecting prices, Cleaver has witnessed the rise of online grocers, the spread of chain stores and the decline of independent corner shops. Will web scraping spell more change for inflation's foot soldiers, or even their ultimate demise?

She is serene. "If it's going to happen, there's nothing we can do." But for now she feels there is still a place for boots on the ground. "The internet is so inconsistent."

Gooding insists that as long as people use shops there will be collectors.
Topics

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The UK's inflation foot soldiers: how the ONS measures the CPI

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In a shop stacked to the ceiling with toys, Brenda Cleaver is searching for a very specific car. "I am looking for a modern road vehicle, and I am checking the price. Here it is. It hasn't changed," she says, comparing the price sticker on the toy car with the information on her handheld computer.

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We've just flicked the switch on moving all our digital resources to instant digital download - via our new subject stores.

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UK inflation in the Brexit years | tutor2u Economics

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George Buckley has been a good friend of Tutor2u over the years. He explains things really clearly for A level students - this is a good example as he explores some of the factors that will affect inflationary pressures in the UK up to and beyond the date of formally leaving the EU.

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Inflation - Problems in Forecasting Inflation | tutor2u Economics

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Why is the rate of inflation difficult to forecast accurately?

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Fiscal policy:

1. Controlling aggregate demand is important if inflation is to be controlled. If the government believes that AD is too high, it may choose to 'tighten fiscal policy' by reducing its own spending on public and merit goods or welfare payments

2. It can choose to raise direct taxes, leading to a reduction in real disposable income

3. The consequence may be that demand and output are lower which has a negative effect on jobs and real economic growth in the short-term

Monetary policy:

1. A 'tightening of monetary policy' involves the central bank introducing a period of higher interest rates to reduce consumer and investment spending

2. Higher interest rates may cause the exchange rate to appreciate in value bringing about a fall in the cost of imported goods and services and also a fall in demand for exports (X)

Supply side economic policies:

Supply side policies seek to increase productivity, competition and innovation - all of which can maintain lower prices. These are ways of controlling inflation in the medium term

i.A reduction in company taxes to encourage greater investment

ii.A reduction in taxes which increases risk-taking and incentives to work - a cut in income taxes can be considered both a fiscal and a supply-side policy

iii.Policies to open a market to more competition to increase supply and lower prices

Rising productivity will cause an outward shift of aggregate supply

Direct controls - a government might choose to introduce direct controls on some prices and wages

1. Public sector pay awards - the annual increase in government sector pay might be tightly controlled or even froze (this means a real wage decrease).

2. The prices of some utilities such as water bills are subject to regulatory control - if the price capping regime changes, this can have a short-term effect on the rate of inflation

Evaluation points - how best can inflation be controlled?

The most appropriate way to control inflation in the short term is for the government and the central bank to keep control of aggregate demand to a level consistent with our productive capacity

AD is probably better controlled through the use of monetary policy rather than an over-reliance on using fiscal policy as an instrument of demand-management

Controlling demand to limit inflation is likely to be ineffective in the short run if the main causes are due to external shocks such as high world food and energy prices

The UK is an open economy in which inflation is strongly affected by events in the rest of the world

In the long run, it is the growth of a country's supply-side productive potential that gives an economy the flexibility to grow without suffering from acceleration in cost and price inflation.

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Inflation - Policies to Control Inflation | tutor2u Economics

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Fiscal policy: Controlling aggregate demand is important if inflation is to be controlled.

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Inflation & Unemployment Revision Quiz | tutor2u Economics

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We've just flicked the switch on moving all our digital resources to instant digital download - via our new subject stores. For every subject you can now access each digital resource as soon as it is ordered. This will always be the latest edition of each resource too (and we'll update you automatically if there is an upgraded version to use).

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Internal and External Causes of Inflation

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Internal and External Causes of Inflation

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This short topic video looks at Internal and External Causes of Inflation.

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Causes of Inflation I A Level and IB Economics

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This revision video looks at the definition and measurement of consumer price inflation in the UK economy.

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This short video looks at changes to the consumer price index which is used to calculate the annual rate of inflation for the UK economy. In 2015-16, coffee pods and music downloads were added but nightclubs and cooked slice turkey was discarded? Why? !

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Many governments have set their central banks a target for a low but positive rate of inflation. They believe that persistently high inflation can have damaging economic and social consequences.

1. Income redistribution: One risk of higher inflation is that it has a regressive effect on lower-income families and older people in society. This happen when prices for food and domestic utilities such as water and heating rises at a rapid rate

2. Falling real incomes: With millions of people facing a cut in their wages or at best a pay freeze, rising inflation leads to a fall in real incomes.

3. Negative real interest rates: If interest rates on savings accounts are lower than the rate of inflation, then people who rely on interest from their savings will be poorer. Real interest rates for millions of savers in the UK and many other countries have been negative for at least four years

4. Cost of borrowing: High inflation may also lead to higher borrowing costs for businesses and people needing loans and mortgages as financial markets protect themselves against rising prices and increase the cost of borrowing on short and longer-term debt. There is also pressure on the government to increase the value of the state pension and unemployment benefits and other welfare payments as the cost of living climbs higher.

5. Risks of wage inflation: High inflation can lead to an increase in pay claims as people look to protect their real incomes. This can lead to a rise in unit labour costs and lower profits for businesses

6. Business competitiveness:If one country has a much higher rate of inflation than others for a considerable period of time, this will make its exports less price competitive in world markets. Eventually this may show through in reduced export orders, lower profits and fewer jobs, and also in a worsening of a country's trade balance. A fall in exports can trigger negative multiplier and accelerator effects on national income and employment.

7. Business uncertainty: High and volatile inflation is not good for business confidence partly because they cannot be sure of what their costs and prices are likely to be. This uncertainty might lead to a lower level of capital investment spending.

Overall, a high and volatile rate of inflation is widely considered to be damaging for an economy that trades in international markets. In your analysis focus on the impact on

Uncertainty / business and consumer confidence

The competitiveness of producers in international markets

The effects on the real standard of living

The possible impact on levels of income inequality

Deflation (negative inflation) can also be damaging for a country. You can read more about deflation in this study note.

Some possible winners and losers from a period of high inflation

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Inflation - Consequences of Inflation | Economics | tutor2u

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Many governments have set their central banks a target for a low but positive rate of inflation. They believe that persistently high inflation can have damaging economic and social consequences. Income redistribution: One risk of higher inflation is that it has a regressive effect on lower-income families and older people in society.

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Deflation - very useful notes and videos

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Deflation - very useful notes and videos

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Some countries have experienced periods of deflation in recent years; perhaps the most well-known example was Japan during the late 1990s and in the current decade. In Japan, the root cause of deflation was slow growth and a high level of spare capacity that was driving prices lower.

Greece and a number of Euro Area countries are now experiencing price deflation as are countries such as Switzerland and Denmark

Why might deflation be damaging for an economy?

1. Holding back on spending: Consumers may postpone demand if they expect prices to fall in the future

2. Debts increase: The real value of debt rises with deflation and higher real debts can be a big drag on consumer confidence

3. The real cost of borrowing increases: Real interest rates will rise if nominal rates of interest do not fall in line with prices.

4. Lower profit margins: Lower prices can mean reduced revenues & profits for businesses - this can then lead to higher unemployment as firms seek to reduce costs by shedding labour.

5. Confidence and saving: Falling asset prices such as price deflation in the housing market hits personal sector wealth and confidence

6. Income distribution: Deflation leads to a redistribution of income from debtors to creditors - but debtors may then default on loans

7. Deflation can make exporters more competitive eventually - but this often comes at a cost i.e. higher unemployment in short term

What economic policies might be used to avoid a period of price deflation?
The main approach to avoiding deflation is to use macro-stimulus policies either by loosening monetary policy and/or fiscal policy
Low interest rates and quantitative easing

In some countries, policy interest rates have become negative e.g. Switzerland and Japan

Cheaper loans for businesses and households

Expanding the supply of credit in banking system

QE used by many central banks including BoE and European Bank

Fiscal stimulus measures

Higher government spending (e.g. capital projects)

A rise in government borrowing to inject demand into the circular flow

Lower direct taxes to increase disposable income and spending

Other measures to stimulate aggregate demand

Attempts to lower (devalue) the value of the exchange rate (perhaps via central bank intervention to sell their currency in the market)

Higher taxes on savings to encourage consumption

Relevant articles on the issue of deflation
(BBC, Jan 2015): Denmark, Deutschland and deflation: strange times for EU http://www.bbc.co.uk/news/business-31050192

(BBC Robert Peston, Jan 2015): Could 'good' low inflation become 'bad' deflation? http://www.bbc.co.uk/news/business-30795424

Deflation danger for the Euro? http://www.bbc.co.uk/programmes/p02g37r1

(BBC Robert Peston, Oct 2014) Why Germant won't fight price deflation http://www.bbc.co.uk/news/29649073

(Guardian, Jan 2015) Analysts fear financial crisis as Chinese deflation looms: http://www.theguardian.com/business/2015/jan/09/ch...

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Explaining Price Deflation - Causes, Effects and Policies | tutor2u Economics

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Some countries have experienced periods of deflation in recent years; perhaps the most well-known example was Japan during the late 1990s and in the current decade. In Japan, the root cause of deflation was slow growth and a high level of spare capacity that was driving prices lower.

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Consequences of Inflation I A Level and IB Economics

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Inflation is a sustained rise in the general price level. Inflation can come from both the demand and the supply-side of an economy

Inflation can arise from internal and external events

Some inflationary pressures direct from the domestic economy, for example the decisions of utility businesses providing electricity or gas or water on their tariffs for the year ahead, or the pricing strategies of the food retailers based on the strength of demand and competitive pressure in their markets.

A rise in the rate of VAT would also be a cause of increased domestic inflation in the short term because it increases a firm's production costs.

Inflation can also come from external sources, for example a sustained rise in the price of crude oil or other imported commodities, foodstuffs and beverages.

Fluctuations in the exchange rate can also affect inflation - for example a fall in the value of the pound against other currencies might cause higher import prices for items such as foodstuffs from Western Europe or technology supplies from the United States - which feeds through directly or indirectly into the consumer price index

Demand-pull inflation

Demand pull inflation occurs when aggregate demand is growing at an unsustainable rate leading to increased pressure on scarce resources and a positive output gap

When there is excess demand, producers can raise their prices and achieve bigger profit margins

Demand-pull inflation becomes a threat when an economy has experienced a boom with GDP rising faster than the long-run trend growth of potential GDP

Demand-pull inflation is likely when there is full employment of resources and SRAS is inelastic

What are the main causes of Demand-Pull Inflation?

1. A depreciation of the exchange rate increases the price of imports and reduces the foreign price of a country's exports. If consumers buy fewer imports, while exports grow, AD in will rise - and there may be a multiplier effect on the level of demand and output

2. Higher demand from a fiscal stimulus e.g. lower direct or indirect taxes or higher government spending. If direct taxes are reduced, consumers have more disposable income causing demand to rise. Higher government spending and increased borrowing creates extra demand in the circular flow

3. Monetary stimulus to the economy: A fall in interest rates may stimulate too much demand - for example in raising demand for loans or in leading to house price inflation. Monetarist economists believe that inflation is caused by "too much money chasing too few goods" and that governments can lose control of inflation if they allow the financial system to expand the money supply too quickly.

4. Fast growth in other countries - providing a boost to UK exports overseas. Export sales provide an extra flow of income and spending into the UK circular flow - so what is happening to the economic cycles of other countries definitely affects the UK

Cost-push inflation
Cost-push inflation occurs when firms respond to rising costs by increasing prices in order to protect their profit margins.

There are many reasons why costs might rise:

1. Component costs: e.g. an increase in the prices of raw materials and other components. This might be because of a rise in commodity prices such as oil, copper and agricultural products used in food processing. A recent example has been a surge in the world price of wheat.

2. Rising labour costs - caused by wage increases, which are greater than improvements in productivity. Wage costs often rise when unemployment is low because skilled workers become scarce and this can drive pay levels higher. Wages might increase when people expect higher inflation so they ask for more pay in order to protect their real incomes. Trade unions may use their bargaining power to bid for and achieve increasing wages, this could be a cause of cost-push inflation

3. Expectations of inflation are important in shaping what actually happens to inflation. When people see prices are rising for everyday items they get concerned about the effects of inflation on their real standard of living. One of the dangers of a pick-up in inflation is what the Bank of England calls "second-round effects" i.e. an initial rise in prices triggers a burst of higher pay claims as workers look to protect their way of life. This is also known as a "wage-price effect"

4. Higher indirect taxes - for example a rise in the duty on alcohol, fuels and cigarettes, or a rise in Value Added Tax. Depending on the price elasticity of demand and supply for their products, suppliers may choose to pass on the burden of the tax onto consumers.

5. A fall in the exchange rate - this can cause cost push inflation because it leads to an increase in the prices of imported products such as essential raw materials, components and finished products

6. Monopoly employers/profit-push inflation - where dominants firms in a market use their market power (at whatever level of demand) to increase prices well above costs

A summary of some of the main inflationary forces in an economy

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Inflation - Main Causes of Inflation | tutor2u Economics

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Inflation is a sustained rise in the general price level. Inflation can come from both the demand and the supply-side of an economy Inflation can arise from internal and external events Some inflationary pressures direct from the domestic economy, for example the decisions of utility businesses providing electricity or gas or water on their tariffs for the year ahead, or the pricing strategies of the food retailers based on the strength of demand and competitive pressure in their markets.

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Interpreting Cost Push Inflation as a tax

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Interpreting Cost Push Inflation as a tax

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If demand is inelastic who bears most of the burden of the increase in a firms costs

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Draw and AS/AD diagram to show Demand-Pull Inflation

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List and Explain 5

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Draw an AS/AD diagram to show Cost-Push Inflation

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