This lesson compares two different types of inflation and examines the tools available to a government, to help reduce inflationary pressures in the economy. There is also a short activity which considers the two perspectives of inflation, monetarist and keynesian.
What is inflation and how is it caused? What measures can a government take to reduce the rate of inflation in the economy?
Lesson time: 90 minutes
Distinguish between inflation, disinflation and deflation.
Explain, using a diagram, that demand-pull inflation is caused by changes in the determinants of AD, resulting in an increase in AD.
Explain, using a diagram, that cost-push inflation is caused by an increase in the costs of factors of production, resulting in a decrease in SRAS.
Evaluate government policies to deal with the different types of inflation.
Inflation is a sustained increase in the general or average level of prices.
Deflation is a sustained decrease in the average level of prices (general price level) in an economy.
Disinflation - when the rate of inflation falls, this is not the same as deflation as prices are still rising but at a slower rate than before.
Demand pull inflation - the result of when rises in AD are greater than the countries ability to produce those goods and services.
Cost push inflation - the result of a rise in production costs.
The activities on this page can be accessed as a PDF file at: Inflation
Start with a simple revision exercise by drawing two short run aggregate supply and aggregate demand curves. On the first illustrate the impact of a rise in production costs in the economy. Now on the second show the effect on one of these diagrams of a rise in economic activity in the economy.
If you have drawn these diagrams correctly then you should see a rise in average prices (inflation). You will have drawn both types of inflation - cost push (supply side) inflation and demand pull (demand side) inflation.
Start by watching the following short video and then answer the questions that follow:
(a) What are the two causes of inflation identified in the video?
(b) What is the ideal rate of inflation for an economy? Wouldn't an inflation rate of 0 be ideal for a country?
Activity 3: Demand pull and cost push inflation
(a) Why do many economists regard demand pull inflation as good inflation?
(b) Why do economists regard cost push inflation to be 'bad inflation'?
(c) Is demand pull inflation really good?
(d) Provide examples of some of the causes of both types of inflation.
Activity 4: Keynesian v Monetarist view of inflation
Start with the following video and the complete the activities which follow:
(a) What is the Fischer equation:
(b) Explain the difference between keynesian and monetarist views of inflation?
(c) Which of the two inflation perspectives (keynesian or monetarist) do you believe is the more correct?
Activity 5: Reducing inflationary pressures
The diagram to the right illustrates an economy in equilibrium.
(a) Identify some of the supply side measures that a government might employ to reduce the rate of inflation in the economy. Illustrate this on your diagram.
(b) Identify some demand side policies that might reduce inflation within the economy? Illustrate this on a diagram, showing the fall in real output.
Activity 6: The difficulty of reducing inflationary pressures
Complete the following table which outlines some of the difficulties that governments have in managing inflation:
Activity 7: Inflation in Uganda
Watch the following short video and explain briefly the measures that the Ugandan central bank has taken to reduce inflationary pressures in the economy?
Activity 8: Link to the paper one assessment
An examples of typical paper one question includes:
(a) Illustrate the difference between cost push and demand pull deflation. [10 marks]
Using real life examples, evaluate different policies that a government might implement to reduce inflationary pressure in the economy. [15 marks]
Activity 9: Which countries in the world have the worlds highest inflation rate?