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Discuss whether an inflation rate of 5% might cause problems for the UK economy

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Introduction

January 2002 - The National and International Economy Discuss whether an inflation rate of 5% might cause problems for the UK economy. I think that an inflation rate of 5% could cause problems for the UK economy. The definition of inflation is that it is the measurement of the annual percentage change in prices, and it often occurs due to rising demand, which raises prices (demand pull inflation). For the last few years, the inflation rate has been at around 2.5%, which is the governments target rate. Partly due to this fact, the UK economy has been one of the strongest in Europe in the last 5 years, and this firstly tells us that an inflation rate of 5% would be bad for the UK economy. I will now look at the problems that an inflation rate of 5% could cause. Firstly, inflation can cause inequality of income. For example, if pensioner's incomes do not rise at the same rate as inflation, then they will be worse of in real terms. ...read more.

Middle

This could lead to major problems in the UK economy as not only will it increase our balance of trade deficit, it could, and would be likely to cause unemployment as labour is a derived demand, and so reduced demand will lead to the loss of jobs, which can then lead to further problems, for example a fall in real GDP, and a recession could occur. UK firms would find it very difficult to compete internationally, as their costs would be increased. This could lead to the closure of UK firms - this would be very bad for the UK economy. Also, an inflation rate of 5% would cause an increase in demand for imports, as they would be cheaper when compared to our countries goods, and this would cause the same problem as is seen with exports. However, we have to remember that this is relative to other countries, for example, if all of the UK's main trading countries have an inflation rate of above 5%, and the UK's inflation rate is 5%, then the problems I have suggested would not happen, as our exports would be cheaper in other countries, and imports would be more expensive in relative terms. ...read more.

Conclusion

So if inflation was at 5%, and wages increased by the same percent, the firms may pass these costs onto consumers, so prices would increase, leading to even higher inflation. This effect is a wage price spiral, which would be prominent in the economy if inflation were high. However, if inflation were low, then firms would be more likely to absorb the costs, and so this effect wouldn't occur - obviously good for the economy. Also, even if the firms didn't absorb the increased wages, the wage price spiral effect wouldn't be as dramatic as if inflation were high, because prices wouldn't increase so much. As you can see, I think that an inflation rate of 5% would be harmful and cause problems for the UK economy, even if others countries had this inflation rate and higher because although the problems I have shown that could occur to competitiveness wouldn't occur, there would be major problems in the UK economy. I don't think that there are any benefits of having an inflation rate of 5%, and so problems would definitely happen if the inflation rate were at 5%. ...read more.

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Response to the question

This essay engages averagely with the question. There is a clear appreciation of the consequences of inflation, including income inequality, international competitiveness and uncertainty. This essay would've scored highly if it was a simple "Explain the consequences of inflation". However, ...

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Response to the question

This essay engages averagely with the question. There is a clear appreciation of the consequences of inflation, including income inequality, international competitiveness and uncertainty. This essay would've scored highly if it was a simple "Explain the consequences of inflation". However, this task is wanting a discussion. If I were answering this question, I would be focusing on how high the inflation rate is above the target, and how high it is compared to other countries. I would then be exploring the effects depending on how long the inflation occurs, and what the cause is, and whether policies would be effective in reducing the rate if need be. Such further discussion beyond the simple consequences is vital to gain the top marks.

Level of analysis

The analysis here is good, and concepts are explained well. What I liked about this essay is that it doesn't simply assert "inflation can cause inequality of income" but dedicates a whole paragraph to explain it. I would've liked to have seen some discussion of the unemployed being affected by inflation, as they also receive unemployment benefits from the government which may not follow inflationary increases. What I really liked about the paragraph discussing international competitiveness is the awareness that "it would not be right to ever assume that the UK’s main trading partners would have an inflation rate of above 5%" and so it is crucial to discuss the inflation rate in the UK in relation to other economies. This shows the examiner you have the ability to evaluate beyond simple knowledge. A diagram could've been beneficial here, looking at how a loss in international competitiveness will reduce aggregate demand and so cause an increase in unemployment. It is that extra step of explanation which is required here. The wage-price spiral is a sophisticated concept, so it was nice to see that explored here. I would've liked to have seen some discussion of a 5% inflation rate making a wage-price spiral more likely. Yet, there is always the other side to inflation and there are some benefits. A high rate of inflation allows firms to increase wages marginally below inflation to reduce the real wage rate, making labour unit costs lower. Such alternative arguments should be looked at to gain the top marks.

Quality of writing

This essay has a solid structure, moving from simple definitions to analysis. As mentioned above, there is a lack of thorough evaluation. This is evident as the essay ends with "I think that an inflation rate of 5% would be harmful". I would always advise you don't use the first person, as it gives an impression of opinionated views, rather than being backed up by strong analysis and good evaluation. Technical terms are used well here, and spelling and grammar are fine.


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