Cambridge International Catalogue 2024 - Final - Flipbook - Page 59
CAMBRIDGE IGCSETM AND O LEVEL ECONOMICS
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Cambridge IGCSE and O Level Economics Student’s Book Second edition
Inflation and deflation
Exam practice
Study tip
Low rates of inflation, of
one or two per cent, are
not usually harmful to the
economy as higher prices
can encourage firms to
supply more output. It
is when inflation rises
too quickly that it can
disrupt decision making
for individuals, firms and
governments.
The hypothetical data below shows the inflation rates for a country over three
years.
Year
1
2
3
Inflation rate (%)
2.5
1.7
2.3
1 Define the meaning of ‘inflation rate’.
2 Explain why the rate of inflation was at its highest in the third year.
[2]
[3]
Deflation
Definition
Deflation is the sustained
fall in the general price
level in an economy over
time, i.e. the inflation rate
is negative.
Table 31.2 Deflation rates
around the world, 2017
Country
Deflation
rate (%)
Somalia
-3.5
Chad
-3.1
Seychelles
-1.2
Benin
-1.0
Iraq
-0.8
Barbados
-0.5
Togo
-0.4
Saudi Arabia
-0.4
Aruba
-0.3
Source: www.
tradingeconomics.com
Whilst the price of goods and services tend to rise, the price of some products
actually falls over time. This is perhaps due to technological progress or a fall in
consumer demand for the product, both of which can cause prices to fall.
Deflation is defined as the persistent fall in the general price level of goods and
services in the economy, i.e. the inflation rate is negative. Some of the countries
that experienced deflation in 2017 are shown in Table 31.2.
The causes of deflation can be categorised as either demand or supply factors.
Deflation is a concern if it is caused by falling aggregate demand for goods
and services (often associated with an economic recession and rising levels of
unemployment).
Deflation can be caused by higher levels of aggregate supply, thus increasing
the productive capacity of the economy. This drives down the general price
level of goods and services whilst increasing national income. Such deflation is
called benign deflation (non-threatening deflation). For example, supply-side
policies such as investment in education and infrastructure (see Chapter 28),
higher productivity, improved managerial practices, technological advances or
government subsidies for major industries all help to raise national income in the
long run. In Figure 31.2, this is shown diagrammatically by a rightwards shift
of the aggregate supply curve from AS1 to AS2, reducing the general price level
from PL1 to PL2. This happened in China during the past three decades with the
Chinese government pouring huge amounts of investment funds into building
new roads and rail networks (the country plans to spend $503 billion on railway
expansion by 2020!).
AS2
AS
General price
level ($)
General price
level ($)
AS1
P1
P2
P1
P2
AD1
AD
O
Y1
Y2
National income
▲ Figure 31.2 Deflation caused by supply factors
AD2
O
Y2
Y1
National income
▲ Figure 31.3 Deflation caused by demand factors
5
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