Inflation 8th October 2015 LO:  To be able to explain the 2 types of inflation  To develop our AO3 analysis skills

P12

Defining inflation Inflation is a sustained increase in the average price level of a country. The rate of inflation is measured by the annual percentage change in the level of prices as measured by the Consumer Price Index (CPI).

What are the main causes of inflation? Watch this videoclip & note down 3 different factors mentioned as causes of inflation Stretch yourself – try to explain how these factors might have led to price increases

Two types of inflation  Demand-pull inflation  Cost-push inflation

Demand pull inflation…

Showing demand-pull inflation on an AD/AS diagram Price Level Real National Output Y1Y1 0 ADAD What would happen to the AD curve if there was an increase in AD? ASAS PL 1

Showing demand-pull inflation on an AD/AS diagram Price Level Real National Output Y1Y1 0 ADADASAS PL 2 AD2AD2 Y2Y2 PL 1 For at least 3 of these factors, start thinking about the steps involved in shifting AD to the right What might have caused AD shift to the right? List as many factors as possible - remember C + I + G + (X - M)

Inflation 8th October 2015 LO:  To be able to explain the 2 types of inflation  To develop our AO3 analysis skills

Assessment Objectives

What are they? Assessment Objectives (AO’s) are the skills you need to show and will be ultimately assessed against in your final examinations Questions are structured to target certain AO’s to test the skills you have developed

Assessment objective 1: Knowledge (22%) KNOWLEDGE AND UNDERSTANDING of a fact, a reason for something, a concept/theory IDENTIFICATION of key points

Assessment objective 2: Application (22%) Using knowledge and understanding IN CONTEXT Use of DATA/EXTRACTS in answer Use of EXAMPLES TO ILLUSTRATE POINTS Manipulation of data e.g CALCULATIONS based on data Use of SUPPLY & DEMAND or AD/AS DIAGRAMS

Assessment objective 3: Analysis (28%) Selecting and applying the APPROPRIATE THEORIES/CONCEPTS Identifying and explaining possible CAUSAL LINKS Identifying and explaining POSSIBLE CONSEQUENCES A CHAIN OF REASONING: can be exemplified by explaining causes and consequences These are what we are going to be focussing on in the next set of exercises…. ….and building these

Assessment objective 4: Evaluation (28%) Showing a CRITICAL AWARENESS Recognising DIFFERENT VIEWPOINTS and BALANCE Questioning QUALITY OF THE EVIDENCE validity and reliability Questioning validity and underlying assumptions Making INFORMED JUDGEMENTS Proposing a SOLUTION and /or RECOMMENDATIONS

The government decides to reduce the level of Income Tax and Corporation Tax. Explain how might this lead to demand-pull inflation? Disposable income, households Consumption Investment, firms Aggregate Demand, Average Price Level Compare answers with the pair in-front of/behind you. Can you improve your answer?

The government decides to reduce the level of Income Tax and Corporation Tax. Explain how might this lead to demand-pull inflation? Disposable income, households Consumption Investment, firms Aggregate Demand, Average Price Level A reduction in the level of Income Tax will leave households with more disposable income as they do not have to pay as much of their income over to the government in the form of taxation.. This additional disposable income is likely to be spent on goods and services which would be an increase on consumption. The reduction in the level of Corporation Tax will mean that firms will be able to retain more of their profits rather than pay them over to the government in the form of taxation, giving them the option to spend more of their profits on investment.. As both consumption and investment are components of Aggregate Demand, the AD curve will shift right and the Average Price Level will increase, showing evidence of demand-pull inflation. How can we show good application in your answer by drawing and referring to an AD/AS diagram?

The government decides to reduce the level of Income Tax and Corporation Tax. Explain how might this lead to demand-pull inflation? Disposable income, households Consumption Investment, firms Aggregate Demand, Average Price Level A reduction in the level of Income Tax will leave households with more disposable income as they do not have to pay as much of their income over to the government in the form of taxation.. This additional disposable income is likely to be spent on goods and services which would be an increase on consumption. The reduction in the level of Corporation Tax will mean that firms will be able to retain more of their profits rather than pay them over to the government in the form of taxation, giving them the option to spend more of their profits on investment.. As both consumption and investment are components of Aggregate Demand, the AD curve will shift right from AD to AD 2 with Real National Output increasing from Y 1 to Y 2 and the Average Price Level will increase from PL 1 to PL 2, showing evidence of demand-pull inflation.

The government commits another £3 bn towards the building of another runway at Gatwick. Explain how might this lead to demand- pull inflation? Government spending, injection, circular flow, contracts for firms, jobs for households, increase, consumption, Aggregate Demand, Average Price Level Example 2 – stretch and challenge. Can you complete the chain of analysis on your own?

The government commits another £3 bn towards the building of another runway at Gatwick. Explain how might this lead to demand- pull inflation? Government spending, injection into Circular Flow, Contracts for firms, jobs for households Consumption Aggregate Demand, Average Price Level

The Bank of England reduces the interest rate by 1% and all of the other lenders follow suit? Explain how this might lead to demand- pull inflation Cost of borrowing, saving, mortgages, disposable income, investment, consumption, Aggregate Demand, Average Price Level

Recent surveys reveal that there are increasing levels of both consumer and business confidence in the UK. Explain how this can lead to demand-pull inflation Future of the economy, households, firms, borrowing, consumption, investment, savings, Aggregate Demand, Average Price Level

Cost push inflation

Showing cost-push inflation on an AD/AS diagram Price Level Real National Output Y1Y1 0 ADAD What would happen if there was a decrease in AS? ASAS PL 1

Showing cost-push inflation on an AD/AS diagram Price Level Real National Output Y1Y1 0 ADADASAS PL 1 Y2Y2 PL 2 AS2AS2

There is an increase in the worldwide price of oil. Explain how might this lead to cost- push inflation? Firms, costs of production Prices, profit margins Widespread, Aggregate Supply, Average Price Level