IB Economics Macroeconomic Policies Student activity: 2.10 Low and Stable Rate of Inflation

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1 Student activity: 2.10 Low and Stable Rate of Inflation IB Economics: INFLATION: STUDENT LEARNING ACTIVITY Answer the questions that follow. 1. DEFINITIONS Define the following terms: Base period Consumer price index Cost of production Cost push inflation Deflation Deflationary gap Demand pull inflation Disinflation Disposable income Fiscal policy Full employment level of output (YF) Inflation Inflationary gap Interest Interest rate Monetary policy Nominal income Nominal rate of interest Nominal rate of return Output gap Philips curve Price index Producer price index Productivity Profit margin Purchasing power Rate of inflation Real income Real rate of return Real value of money Resources Returns on investment Stagflation Supply side policies Supply side shocks [10 marks] 1 P a g e

2 2. SHORT-ANSWER QUESTIONS 1. Distinguish between inflation, disinflation and deflation. [3 marks] 2. Use numerical data to distinguish between inflation, disinflation and deflation. [3 marks] 2 P a g e

3 3. Distinguish between an increase in the rate of inflation and an increase in the price level. Use examples. [3 marks] 4. Outline the meaning and purpose of the consumer price index (CPI). 3 P a g e

4 5. Explain why the consumer price index (CPI) is unlikely to be representative of the inflation experienced by all households in an economy. 6. Distinguish between the producer price index and the (PPI) consumer price index (CPI). [2 marks] 4 P a g e

5 7. Explain how an increase in the producer price index (PPI) is likely to affect the consumer price index. 8. Outline the concept of core inflation. [2 marks] 9. Explain how inflation affects household purchasing power. Use numerical examples. 5 P a g e

6 10. Explain the effect on household purchasing power (real income) when: a. The rate of inflation is 5% and nominal household income increases by 4% b. The rate of inflation is 4% and nominal household income decreases by 4% c. The rate of inflation is 5% and nominal household income increases by 5% [3 marks] 11. Outline the main negative effects of inflation. [6 marks] 6 P a g e

7 12. Explain which groups lose as inflation affects the redistribution of purchasing power. 13. Explain which groups lose as inflation affects the redistribution of purchasing power. 7 P a g e

8 14. Distinguish between demand-pull and cost-push inflation. [6 marks] Demand-pull inflation Cost-push inflation 8 P a g e

9 15. Explain why cost-push inflation can be more damaging to an economy than demand-pull inflation. 16. Explain the effect of the following event on the price level: Strong economic growth in a major export destination; and identify whether the following is demand-pull or cost-push inflation. [3 marks] 9 P a g e

10 17. Explain the effect of the following event on the price level: An increase in producer confidence; and identify whether the following is demand-pull or cost-push inflation. [3 marks] 18. Explain the effect of the following event on the price level: An increase in housing prices; and identify whether the following is demand-pull or cost-push inflation. [3 marks] 10 P a g e

11 19. Explain the effect of the following event on the price level: A sudden and significant rise in the price of oil; and identify whether the following is demand-pull or cost-push inflation. [3 marks] 20. Outline the main negative effects of deflation. [10 marks] 11 P a g e

12 21. Explain why a constant price level (rate of inflation = 0%) is not the optimum rate for an economy. 12 P a g e

13 B. SKILLS APPLICATION American antitrust regulators rule that the Ford and Hyundai merger can proceed NEW YORK The US rate of inflation remains low. Washington. November 16, REUTERS/MILENA BAENSCH The consumer price index in the US rose by just 0.2% in November from the year before, compared to 0.1% in October and -0.5 in September. The core inflation rate which excludes food and energy costs, increased 0.5% year-onyear. The producer price index, based on 625 products, showed a much higher increase of 4.4%. This reflected increases in agricultural, mining and industrial costs. The falling and persistently low rate of inflation reflects consumer caution in spending, which is due to political turmoil in the Whitehouse, and the dysfunctional Republican majority House and Senate failing to pass any real legislative agenda. In a statement from the Whitehouse, President Trump decried the fake news establishment and said that low and falling prices were great news, I have heard from hundreds of people that tell me that they like lower prices. I m going to work to get prices even lower. It's going to be amazing. Believe me." 13 P a g e

14 QUESTIONS 1. Outline the following terms: [6 marks] i. Consumer price index (CPI) ii. Producer price index (PPI) iii. Core inflation 2. Using examples from the article, distinguish between the concepts of inflation, deflation and disinflation. 3. Explain how an increase in the US PPI is likely to predict changes in the CPI affecting US households. 4. Use diagrams to distinguish between demand-pull inflation and cost-push inflation. 5. Explain why the rate of US inflation is more likely to be a product of demand-pull inflation rather than cost-push inflation? 6. Explain why President Trump is misguided in his thinking about deflation being a positive thing for the US economy? HIGHER LEVEL QUESTION ONE: LOW AND STABLE RATE OF INFLATION 1. Use the price index below to answer the following questions: [7 marks] Table 1: Price index information for years Year CPI a. Identify the base year: b. Determine the rate of inflation in the period c. Determine the rate of inflation in the period P a g e

15 d. Determine the rate of inflation in the period e. Determine the rate of inflation in the period f. Identify when deflation occurred: g. Identify when disinflation occurred: 2. The consumer price index is a weighted index. Explain the importance of weights within the index. HIGHER LEVEL QUESTION TWO: LOW AND STABLE RATE OF INFLATION 3. Use the information below to answer the following questions: [10 marks] Good or service Quantity in the basket Weights 2014 unit price ($) Annual change in price CPI price change 2015 unit price ($) Annual change in price CPI price change 2016 unit price ($) Annual change in price CPI price change Pizza Video game Uber ride Totals 15 P a g e

16 a. Identify the weighting for each item above. b. Using 2014 as the base year, construct the CPI (consumer price index) for each year. c. Identify periods when inflation, disinflation and/or deflation occurred. HIGHER LEVEL QUESTION THREE: LOW AND STABLE RATE OF INFLATION 1. Answer the following questions regarding the Phillips curve: a. Outline the concept of the Phillips curve. [3 marks] 16 P a g e

17 2. Explain how events in the s established that the relationship between inflation and unemployment in the short-run was not fixed and permanent (i.e., unstable). b. Outline the concept of stagflation using the AD/AS model. [3 marks] 17 P a g e

18 c. Explain how the relationship between the short-run position of the Philips curve and shifts in the short-run aggregate supply curve can account for stagflation. [6 marks] AD/AS model Phillips curve d. Use diagrams to distinguish between the Phillips curve in the short-run and in the long-run. Short-run Phillips curve Long-run Phillips curve 18 P a g e

19 e. Explain how the long-run Phillips curve informs us of the relationship between the rates of inflation and unemployment. 19 P a g e f. Explain the relationship between the natural rate of unemployment and the long-run Phillips curve.

20 g. Explain the relationship between the full employment level of output and the long-run Phillips curve. h. According to the Phillips curve theory, explain the effect on the rates of inflation and unemployment, and the effect on real GDP if governments attempt to boost aggregate demand in the short-run and the long-run. [10 marks] 20 P a g e

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