General - Inflation

There are various causes of inflation, but there are two main ones to look out for when running the Virtual Economy:

1. Demand-pull inflation
2. Cost-push inflation

Demand-pull inflation happens when the level of demand grows too fast. UK firms cannot keep up with the growth in demand for their products and so prices increase (inflation) and more imports are brought into the country. To counter this and keep inflation down, you may need to reduce the level of demand. You can do this by using deflationary policies. These could include:

• Increasing direct taxes and indirect taxes
• Increasing interest rates
• Reducing the level of government expenditure

Cost-push inflation tends to happen when wages or prices rise too fast. This increases the firm's costs and they have to increase prices again - a wage-price spiral. To avoid this type of inflation, again ensure that economic growth doesn't rise too fast. If the economy grows too fast, this may put pressure on wages to rise. Low unemployment means that many employers will find it difficult to recruit and may have to offer higher wages to attract people.

Why not try some of these policies on the Virtual Economy? Click either on the 4th floor in the side panel or on 'The Model' in the top navigation bar to get to the model. Have a look at the present forecasts for the economy and decide what you think would be the most appropriate policies. Don't deflate the economy too much though - you may find unemployment increasing a lot. Unemployment and inflation do tend to move in opposite directions.

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