4.2 Inflation

What is inflation?

• A decrease in the general price level

• A sustained increase in the general price level

• A constant price level over time

• A decline in consumer spending

Answer explanation

1. Inflation refers to a persistent and sustained rise in the general price level of goods and services in an economy over a period of time.

What measure is used to determine the level of inflation?

• Consumer Price Index
• Gross Domestic Product
• Unemployment Rate
• Interest Rate

Demand-pull inflation occurs when:

• Production costs rise due to factors like higher wages or raw material prices

• Aggregate demand exceeds aggregate supply, leading to rising prices

• Central banks reduce the money supply to control inflation

• Consumer preferences shift towards cheaper goods

Answer explanation

Demand-pull inflation happens when total demand for goods and services surpasses the economy's productive capacity, causing upward pressure on prices.

One of the negative consequences of high inflation is:

• Increased purchasing power for consumers

• Encouragement of long-term saving and investment

• Erosion of real income and savings

• Reduced need for central bank intervention

Answer explanation

High inflation erodes the purchasing power of money, reducing the value of people's income and savings over time.

One limitation of using the CPI as a measure of inflation is that it:

• Does not account for the quality of goods and services
• Measures the price of all goods and services
• Is not affected by changes in the money supply
• Does not include imported goods