How is inflation measured, what causes it, and why do inflation and deflation matter?
Inflation and deflation: the measurement of inflation using a price index, demand-pull and cost-push causes, the effects of inflation and deflation, and the distinction between inflation, disinflation and deflation.
An Eduqas A520 answer to inflation and deflation, covering the measurement of inflation through a weighted price index such as the Consumer Prices Index, demand-pull and cost-push causes, the costs of inflation and of deflation, and the difference between inflation, disinflation and deflation.
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What this dot point is asking
Eduqas wants you to explain how inflation is measured with a weighted price index, distinguish demand-pull from cost-push inflation, set out the effects of inflation and of deflation, and separate inflation, disinflation and deflation. Inflation is a core macroeconomic objective (the Bank of England targets 2 per cent) and a favourite of both data response and essays.
Measuring inflation
The CPI has limitations: it can be unrepresentative for households whose spending differs from the average, it is slow to capture new goods and quality changes, and the older Retail Prices Index (RPI) includes some housing costs the CPI omits, so the two can differ.
Demand-pull and cost-push inflation
Inflation, disinflation and deflation
The effects of inflation
High or volatile inflation:
- Erodes the real value of money, savings and fixed incomes (hurting savers and pensioners).
- Creates uncertainty, deterring investment and long-term contracts.
- Redistributes from lenders to borrowers (the real value of debt falls) and from those without bargaining power.
- Worsens international competitiveness if domestic inflation exceeds that of trading partners, harming the current account.
- Can become self-perpetuating through a wage-price spiral, as workers demand higher wages to match expected inflation.
Low, stable and predictable inflation (around the 2 per cent target) is generally seen as healthy, lubricating relative price changes and avoiding the dangers of deflation.
Examples in context
- The 2022 cost-of-living crisis. A surge in energy and food prices was classic cost-push inflation, pushing UK CPI above 10 per cent.
- The 2 per cent target. The Bank of England's Monetary Policy Committee targets CPI inflation of 2 per cent, raising interest rates to curb demand-pull pressure.
- Japan's lost decades. Persistent mild deflation discouraged spending and investment, illustrating the dangers of falling prices.
Try this
Q1. Explain the difference between disinflation and deflation. [3 marks]
- Cue. Disinflation = the inflation rate falls but stays positive (prices rise more slowly); deflation = the price level actually falls (negative inflation).
Q2. Using an AD-AS diagram, explain how a sharp rise in oil prices could cause cost-push inflation. [4 marks]
- Cue. Higher production costs shift SRAS left, raising the price level and lowering real output and employment (stagflation).
Exam-style practice questions
Practice questions written in the style of WJEC Eduqas exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
Eduqas Component 2 20204 marksA price index rises from 120 in year 1 to 126 in year 2. Calculate the rate of inflation between the two years and explain what would happen to the index if the inflation rate then fell to 2 per cent in year 3 (disinflation).Show worked answer →
A short calculate question. Inflation is the percentage change in the price index.
Year 1 to year 2: inflation.
If inflation in year 3 falls to 2 per cent, that is disinflation (a fall in the rate of inflation, not a fall in prices). The index would still rise, by 2 per cent: . Prices are higher than in year 2, just rising more slowly. Markers reward the 5 per cent calculation and the correct disinflation interpretation (the index still rises).
Eduqas Component 3 (macro) 202212 marksEvaluate the view that cost-push inflation is more damaging than demand-pull inflation.Show worked answer →
A levels-of-response essay. Knowledge and application: define both. Demand-pull inflation comes from excess aggregate demand (a rightward AD shift along an upward-sloping SRAS); cost-push inflation comes from rising costs (a leftward shift of SRAS). Draw both on an AD-AS diagram.
Analysis: develop the key difference: cost-push inflation raises the price level and lowers real output and employment (stagflation), whereas demand-pull inflation is usually accompanied by rising output, at least until full capacity.
Evaluation: weigh that demand-pull inflation can become entrenched through a wage-price spiral and is easier for policy to control (tightening demand), while cost-push from a supply shock is harder to tackle without worsening unemployment. Conclude with a supported judgement, for example that cost-push is often more damaging because it combines inflation with falling output, but the answer depends on the cause and persistence.
Related dot points
- Economic growth and the business cycle: the measurement of GDP and growth, real versus nominal and per-capita measures, the causes of short-run and long-run growth, the phases of the business cycle, and the costs and benefits of growth.
An Eduqas A520 answer to economic growth, covering how GDP and growth are measured, real versus nominal and per-capita GDP, the causes of short-run (actual) and long-run (potential) growth, the four phases of the business cycle and output gaps, and the costs and benefits of economic growth.
- Unemployment: its measurement by the claimant count and the Labour Force Survey, the causes of unemployment (cyclical, structural, frictional and real-wage), and the economic and social costs of unemployment.
An Eduqas A520 answer to unemployment, covering the two measures (the claimant count and the International Labour Organisation Labour Force Survey), the main causes (cyclical, structural, frictional and real-wage unemployment), and the economic and social costs of unemployment, including the distinction between unemployment and underemployment.
- Aggregate demand and aggregate supply: the components of aggregate demand, the determinants of short-run and long-run aggregate supply, macroeconomic equilibrium, and the effects of shifts in AD and AS.
An Eduqas A520 answer to the AD-AS model, covering the four components of aggregate demand and what shifts them, the determinants of short-run and long-run aggregate supply, macroeconomic equilibrium, and how shifts in aggregate demand and supply affect the price level and real national output.
- Monetary policy: interest rates and the transmission mechanism, the role of the central bank and inflation targeting, quantitative easing, and the strengths and weaknesses of monetary policy.
An Eduqas A520 answer to monetary policy, covering how the central bank uses interest rates and the money supply, the monetary transmission mechanism, inflation targeting and the role of an independent central bank, quantitative easing, and the strengths and weaknesses of monetary policy.
Sources & how we know this
- Eduqas A Level Economics Specification (A520) — Eduqas (2015)