Cambridge International Catalogue 2024 - Final - Flipbook - Page 58
CAMBRIDGE IGCSETM AND O LEVEL ECONOMICS
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31 INFLATION AND DEFLATION
Causes of inflation and deflation
represent the remaining 15 per cent. To create a weighted price index, economists
multiply the price index for each item of expenditure (in the representative basket
of goods and services) by the statistical weight for each item. Applying these
weights gives the following results:
Product
Price index
Weight
Weighted index
Definition
Food
110.0
0.40
110 × 0.4 = 44.0
Cost-push inflation
is a cause of inflation,
triggered by higher costs of
production, thus forcing up
prices.
115.0
0.20
115 × 0.2 = 23.0
Transport
116.4
0.25
116.4 × 0.25 = 29.1
Others
123.3
0.15
123.3 × 0.15 = 18.5
Weighted index
Whilst the price of food has increased the least since the base year (by only 10
per cent), food accounts for 40 per cent of the typical household’s spending. So,
this 10 per cent price increase has a much larger impact on the cost of living
than the 15 per cent increase in the price of entertainment, which accounts for
only 20 per cent of the average household’s expenditure. Without using weights,
the average price index would be 116.18, i.e. (110 + 115 + 116.4 + 123.3) / 4.
However, the statistical weights reduce the price index to 114.6 because the
relatively higher prices of non-food items account for a smaller proportion of
spending by the typical household. This shows that prices have, on average,
increased by 14.6 per cent since the base year. Therefore, the use of a weighted
price index is more accurate in measuring changes in the cost of living, and hence
inflation.
Look inside
View sample material
from our Student’s
Books
114.6
Study tip
Although the CPI is the
most widely used price
index for measuring
inflation, it only takes an
average measure. Thus,
the CPI hides the fact that
the price of some products
increases more rapidly than
others, whilst the price of
other products might have
actually fallen.
Exam practice
AS2
General price
level ($)
Entertainment
Item
Consumer Price Index
Weight
Clothing
110
10
Food
120
20
Housing
130
30
Others
140
40
a Define what is meant by a ‘consumer price index (CPI)’.
[2]
b ‘The typical household in Jukeland spends more money on housing than on
food or clothing’. Explain this statement.
[3]
c Use the data above to calculate the weighted consumer price index (CPI) in
Jukeland.
[4]
AS1
P2
P1
AD
O
Y2
Y1
National income
▲ Figure 31.5 Cost-push inflation
▲ Higher rents in popular locations can cause cost-push inflation
Definitions
1 a Calculate the inflation rate if the consumer price index changes from 123.0
to 129.15.
[2]
b Calculate the price index if there is 3.0 per cent inflation during the year if
the index was previously at 130.
[2]
c Calculate how much a basket of goods and services which is currently
priced at $1,200 would cost if the CPI increased from 125 to 135.
[3]
2 The data below is for a hypothetical country, Jukeland.
There are two main causes of inflation: demand-pull inflation and cost-push
inflation. Although aggregate demand (AD) and aggregate supply (AS) analysis is
not required in the IGCSE examination, this has been included in this section for
illustrative purposes only.
Cost-push inflation is caused by higher costs of production, which makes firms raise
their prices in order to maintain their profit margins. For example, in Figure 31.5, higher
raw material costs, increased wages, and soaring rents shift the aggregate supply (total
supply) curve for the economy to the left from AS1 to AS2, forcing up the general price
level from PL1 to PL2 and reducing national income from Y1 to Y2.
Demand-pull inflation
is a cause of inflation,
triggered by higher levels
of aggregate demand in the
economy, thus driving up
the general price level.
Imported inflation is
a cause of inflation
triggered by higher import
prices, forcing up costs
of production and thus
causing domestic inflation.
Demand-pull inflation is caused by higher levels of aggregate demand (total
demand in the economy), thus driving up the general price level of goods and
services. For example, during an economic boom, household consumption of
goods and services increases due to higher GDP per capita and higher levels of
employment. In Figure 31.6, this is shown diagrammatically by a rightwards shift
of the aggregate demand curve from AD1 to AD2, raising national income from Y1
to Y2 and forcing up the general price level from PL1 to PL2.
AS1
General price
level ($)
Table 31.4 Creating a
weighted price index
Causes of inflation and deflation
P2
P1
AD2
AD1
O
▶ Figure 31.6 Demand-pull
inflation
Y1
Y2
National income
Other possible causes of inflation are:
» Monetary causes of inflation are related to increases in the money supply (see case
study on Zimbabwe) and easier access to credit, such as loans and credit cards.
» Imported inflation occurs due to higher import prices, forcing up costs of
production and therefore causing domestic inflation.
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