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Evaluate the possible consequences of a falling rate of inflation for the performance of the UK economy.

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“Evaluate the possible consequences of a falling rate of inflation for the performance of the UK economy.”

This essay will look at how a falling rate of inflation affects macroeconomic policy objectives such as; economic growth, full employment, equilibrium in balance of payments and inflation of 2% + or – 1. Inflation is general rise in price level. A falling rate of inflation simply means that inflation is still rising but not as steeply. There are two types of inflation; cost push and demand pull. Demand pull inflation means that aggregate demand (AD) exceeds aggregate supply (AS) and that there are not enough goods to meet with AD and so prices for goods rise. A diagram below illustrates demand pull inflation.

            Price Level        AD1

        AD                  AS

        Quantity

Demand pull inflation occurs when consumer tastes or consumer confidence changes very quickly and the firms do not adjust their supply quickly enough. Or when exchange rate falls and exports increase, which makes it harder for the economy to adjust its supply in the short term because they are running with full employment for example.  

Cost push inflation occurs when production costs for firms increases and so it becomes more expensive for firms to produce the goods. A diagram below illustrates this.

        Price Level        AD        AS2

     AS

Real Output

AS shifts to the right due to many factors concerning with supply. Natural disasters that wipe out some of the firms raw materials, so there is less real output in the economy, or real wages rise due to trade unions strikes. This means that in order to make the same profit as before the firms have to charge more for their goods.

Inflation will affect macroeconomic policy objectives in different ways, depending on what type of inflation it is. Demand pull inflation will mean that unemployment will fall in the long term because the firm is expected to produce more goods in order to satisfy AD. If the demand pull inflation is caused by falling exchange rates, more exports and fewer imports will be made which will mean that the current account will slightly improve and reduce the deficit in the UK. However it can be argued that if the price level in UK increases, fewer exports will be made because it will be more expensive for other countries to buy goods in UK, so not always will demand pull inflation increase exports and decrease imports.

If inflation is caused by cost push inflation then unemployment is more likely to increase because firms will want less staff to produce the goods if firm’s stock decreases. If real wages rise then firms may want to fire some of its staff to maintain their profits without increasing the price level too high. The actual output in UK will decrease which could result in economic growth to shift inwards.

As mentioned before, falling rate of inflation means that inflation is still rising but less steeply. A low predictable level of inflation could mean that workers will be incentivised to work more because their nominal wages rise which makes them think that they are actually earning more.

This essay attempted to illustrate some consequences of different types of inflation on macroeconomic policy objectives. It attempted to explain that different types of inflation have different effects on the economy. Overall inflation for a long period of time is bad because it is not sustainable and more costs to economy arise.    

This student written piece of work is one of many that can be found in our AS and A Level UK, European & Global Economics section.

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Response to the question

This essay responds well by analysing how a falling rate of inflation will affect the economy. However, the key word in this question is "evaluate" and unfortunately there isn't any here. There should be some discussion of the extent to ...

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Response to the question

This essay responds well by analysing how a falling rate of inflation will affect the economy. However, the key word in this question is "evaluate" and unfortunately there isn't any here. There should be some discussion of the extent to which falling inflation may cause increases in competitiveness, or what this depends upon. I always ask myself "will it always happen?" which prompts you to think of situations where it doesn't. Explaining these situations and coming to a conclusion will ensure you don't miss out on the marks available.

Level of analysis

The analysis here is good. I particularly liked how the introduction made clear that falling inflation does not mean the price level is falling, but instead the rate of inflation is rising slower. Being able to show understanding of this is strong, especially in the introduction, as this is a common mistake in A-Level! It is good to discuss the causes of inflation, but there seems to be too much focus on it here. In my opinion, I would do a diagram to show a cause of inflation, but get straight into the analysis of whether a lower inflation rate in the UK will improve performance. This would lead onto a discussion of whether the inflation rates are higher or lower in other countries, which would prompt foreign investment, stability, confidence, etc. The assertion of "Overall inflation for a long period of time is bad because it is not sustainable and more costs to economy arise." seems to be unfounded. A low and stable inflation rate is a macroeconomic objective for a reason, so I would advise simply stating that inflation is bad. You must remember in economics to back up and claims you make - anyone can state mechanisms, but being able to clearly explain them will gain you the top marks.

Quality of writing

The structure here is good, having a clear introduction and conclusion. I would've defined what economic performance means in the introduction to ensure a clear and cogent argument. The conclusion is weak, however, and adds nothing to the argument. Technical terms are used well, and I liked the focus on "real wages" and "real output" as this is a key concept when dealing with inflation. Spelling, punctuation and grammar are fine. I'm not too sure about the style of "This essay attempted to illustrate" or "This essay will look at how" as it's a waste of time and the word attempt suggests you haven't given enough evidence to make a strong conclusion!


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Reviewed by groat 23/03/2012

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