Explain two causes of demand-pull inflation.

Evaluate the effectiveness of interventionist supply-side policies in reducing demand-pull inflation.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part A.

Answers may include:

• definition of inflation, demand-pull inflation
• diagram showing rising average price level due to an increase in AD
• explanation that AD may increase because of a change in any of the determinants affecting component(s) of AD
• examples of economies that have experienced demand-pull inflation.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part B.

Answers may include:

• definitions of inflation, demand-pull inflation, supply-side policies, interventionist supply-side policies
• AD/AS diagram showing an increase in AD in the short run (increasing the inflationary gap) and an increase in the LRAS (full employment level of output) in the long run (decreasing the inflationary gap)
• explanation that, in the short run, interventionist supply-side policies may increase the inflationary pressure due to their effect on AD, but the inflationary pressure will be reduced in the long run due to the increased productive capacity of the economy
• examples of interventionist supply-side policies in practice
• synthesis or evaluation.

Evaluation may include: consideration of the tension between the inflationary short-run effects and disinflationary long-run effects of interventionist supply-side policies; spending on healthcare, education and infrastructure may improve equality in the distribution of income/equity; interventionist supply-side policies may be expensive and lead to high budget deficits and increased indebtedness; considerable time lags; negative effects on the environment; consideration of the strengths and limitations of alternative policies (e.g. contractionary monetary policy, contractionary fiscal policy, market-based supply-side policies).

NB It should be noted that definitions, diagrams, theory and examples that have already been given in part (a), and then referred to in part (b), should be rewarded.

Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.

Many students did not make it clear that they understand that the inflation is a process and not a one-off increase in the average price level. Another common weakness was using the new classical AD/AS diagrams that shows an economy that recovers from recession (closes a deflationary gap) to illustrate demand-pull inflation. 

There were many students who did not show any awareness of the short-run effects of interventionist supply-side policies on AD. There were also candidates who completely ignored the crucial long-term effects of interventionist supply-side policies in their diagrams and explanations.