Explain the possible causes of inflation

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Inflation in an economy is defined as the sustained increase in the general price level, resulting in a decrease in purchasing power of consumers and a fall in the value of money. Some inflation is vital for the macro economy in order to maintain adequate levels of economic growth, and since 1997, the UK government has recognised this fact by allowing The Bank of England Monetary Policy Committee to target a rate of 2.0% over the past fifteen years or so. The measure currently used by EU countries, including Britain, is that of the CPI (Consumer Price Index). This takes a weighted, indexed mean of a basket of goods deemed to be most influential in current household spending across the country. Other measures include the RPI and RPIX (the RPI, excluding mortgage interest repayments, as these fluctuate too readily). The UK has preserved one of the lowest inflation rates among EU countries in recent years, due to a thorough understanding of the causes of inflation and the policies necessary to manage it.

On a microeconomic level, inflation can arise from the domestic economy. For example, major energy providers may decide to put up prices in line with projections for the year ahead, or monopolistic supermarket chains could engage in pricing wars, often to the detriment of the consumer and the pocket inflation they experience. Government VAT increases to fund its budget deficit would eventually feed through to inflation. On an international level, various commodity shortages or scarcity power from giant oil companies undoubtedly forces inflation further upwards. Frequently, however, the causes of inflation are split into two areas: demand-pull and cost-push.

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Demand-pull inflation is likely to occur when an economy is working at or close to full employment of resources. In the short run, aggregate supply is inelastic and any increases in demand will only be met with price rises, due to upward pressure on material and wage costs. This is as opposed to more resources available as an alternative to fuel the demand. With spare capacity, this will still take place, but to a much lesser extent as firms are confident they can compete in the market without being stretched for resources in the short run. In this state, ...

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The structure here is strong, with the introduction placing in some background knowledge of how inflation is measured and why it is relevant. I like this, as it shows to the examiner immediately that you have a strong understanding. If this essay was a discussion, however, I would normally argue you should keep your introduction short and focussed. Technical terms are used throughout, and the style makes for a convincing argument. This is because each step follows on from the last, showing a clear progression in the argument. I just wanted to see more diagrams!

The analysis in this essay is strong, showing a strong understanding of concepts. I liked how the essay talks about “in the short run, aggregate supply is inelastic” thus causing demand-pull inflation. Being able to incorporate technical terms such as elasticity is a great way to gain marks! The discussion of cost-push inflation is particularly strong, with a reference to the Phillips curve being made. This is beyond the A-Level syllabus and will gain credit for analysis. I would’ve liked to have seen some diagrammatical analysis, as this is the easiest way to demonstrate an understanding of inflation. A simple shift of aggregate demand to show demand pull, and a shift in aggregate supply to show cost push. Whenever I talk about inflation, I always talk about the wage-price spiral, as this shows a strong understanding of mechanisms. This was well explained here!

This essay responds to the question superbly, having a strong understanding of the different causes. I particularly liked the awareness that there are theories of inflation, rather than causes which are set in stone. This is a great skill to have in economics, as it shows an understanding of its relevance as a social science well beyond A-Level. Although the essay doesn’t explicitly ask for policies to reduce inflation, the essay poses a justified judgement to what can be done. I always like when essays go further to incorporate other ideas. This is a great way to revise, as it means you have all the ideas regardless of the question, and can then focus your essay for the exam.