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Monetary Policy - Inflation - Causes

Worksheet 1 - Inflation - pushing or pulling?

The purpose of this worksheet is to look at the principal causes of inflation. It aims to establish what they are and then look at some empirical evidence to see how inflation might have been caused.

1. What is meant by aggregate demand?

(4 Marks)

2. Fill in below the main components of aggregate demand.

AD = ___ + ___ + ___ + (___ - ___)

(4 Marks)

3. Fill in the table below to show what effect you would expect each of the events given, to have on each component of aggregate demand. In each case fill in whether you would expect the component of AD to rise, fall or stay the same and also the reason.

Event	Effect on AD?
	Component of AD	Rise, fall or stay the same?
1. The MPC reduce interest rates	C
	I
	G
	X
	M
2.The government cut the basic rate of income tax	C
	I
	G
	X
	M
3. The government announce a significant rise in government expenditure on education	C
	I
	G
	X
	M
4. The exchange rate appreciates significantly against all major currencies	C
	I
	G
	X
	M
5. There is a stock market crash with shares losing nearly a third of their value	C
	I
	G
	X
	M

(50 Marks)

4. Use either the explanation or the glossary to find out definitions of cost-push and demand-pull inflation. Fill them in below:

Cost-push inflation

Demand-pull inflation

(4 Marks)

5. On the blank axes given below, show cost-push and demand-pull inflation using aggregate demand and aggregate supply analysis. Give a brief explanation of what is happening in your diagrams.

(6 Marks)

6. Use the theory section to find out the principal causes of cost-push inflation.

(5 Marks)

7. For each of the events causing inflation given below, class it as either cost-push inflation or demand-pull inflation.

Cause of inflation	Cost-push, demand-pull or both?
1. A spate of mergers of big companies give increased monopoly power and prices of various goods increase.
2. Rapid economic growth increases wages and as a result prices go up.
3. Cuts in the mortgage rate increase people's disposable income and this leads to inflation.
4. There is a rapid rise in the oil price on world markets causing inflation.
5. A loss of confidence in the UK economy leads to the exchange rate depreciating significantly, causing inflation.
6. Gas begins to run out, pushing the price up and causing inflation.

(6 Marks)

8. Use the data section to find out the rate of economic growth for the last 15 years. Either download this into a spreadsheet, or fill in the figures in the table below. To do this you will need to select the following variable:

ABMI UK GDP constant prices - calculate the change in this to get the level of economic growth

Year	Economic growth (% change in GDP)	Inflation (% change in RPI)	Consumption
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003

Over what period do you think high inflation is most likely? Explain your reasoning.

(5 Marks)

9. Go once again to the data section and now find the figures for inflation for the same years. Once again, download them to a spreadsheet or fill them in in the table above. To do this you will need to select the following variable:

CZBH UK Retail prices all goods and services

Was your prediction about high inflation correct?

If it differed, why do you think this might have happened?

(3 Marks)

10. To try to see if this inflation may have been caused by a growth in demand, go once again to the data section and now find the figures for the growth in consumers expenditure for the same years. Either download them to a spreadsheet or fill them in in the table above. To do this you will need to select the following variable:

ABJR UK Household Expenditure: Total Household Final Consumption Expenditure: £m Seasonally adjusted Constant 1995 prices

To analyse the relationship between consumption and inflation more closely, use either the axes below or your spreadsheet to draw a scatter graph of the % change in consumption against the rate of inflation.

What relationship would we expect to see between these two variables?

(4 Marks)

11. Draw a line of best fit onto the diagram.

How close a fit is the line to the points? (If you have done this on a spreadsheet, you can use the spreadsheet to calculate a 'correlation coefficient' to show how good the relationship is).

(2 Marks)

12. What other factors could we take account of to improve the accuracy of this experiment to see what the cause of demand-pull inflation is?

(4 Marks)

13. What are the main differences between the Keynesian and Classical views of the causes of inflation? Write a brief paragraph outlining the differences and use the blank axes below to show these differences using aggregate supply and demand analysis.

Blank axes for Classical view of inflation

(6 Marks)

14. Fill in the blank boxes in the diagram below to show the effects of a wage-price spiral.

Blank diagram to show the effects of a wage-price spiral

Explain why this happens.

(7 Marks)

Total Marks = 106