Explain the causes of cost-push inflation.

Discuss the view that deflation is more harmful than inflation.

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

Answers may include:

• definitions of inflation, cost-push inflation
• diagram showing cost-push inflation (increase in the price level due to decrease in SRAS)
• explanation that cost-push inflation is caused by an increase in the costs of factors of production 
• example(s) of specific policies/events that may cause cost-push inflation, examples of economies that have experienced cost-push inflation (e.g. USA in the 1970s).

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

Answers may include:

• definitions of inflation, deflation 
• diagrams showing deflation and inflation
• explanation of the possible consequences of high inflation rates (increased uncertainty and more difficult planning, wealth/income redistribution and social tensions, lower savings rate/higher consumption, lower export competitiveness) and the possible consequences of deflation (increased debt burden, bankruptcies and cyclical unemployment, wealth/income redistribution and social tensions, higher savings rate/lower consumption)
• examples of economies that have experienced high inflation rates (e.g. Weimar Republic, Zimbabwe, Venezuela), examples of economies that have experienced deflation (e.g. USA during the Great Depression, Japan), examples of specific cases of negative and/or positive consequences
• synthesis or evaluation (discuss).

Discussion may include: in a progressive taxation system the inflation pushes individuals and businesses into higher income brackets, leading to higher tax revenue for the government and higher tax burden for individuals and businesses; the effect of inflation/deflation on groups with fixed incomes versus the effect on groups with incomes that change with the price level; the importance of the magnitude of price changes (low inflation rates of about 2 % or less may be beneficial for the economy); the importance of how prolonged the inflation/deflation is, whether the inflation/deflation is anticipated or not anticipated, whether the deflation is caused by supply-side or demand-side factors, whether the inflation is demand-pull or cost-push (mild demand-pull inflation may stimulate employment and economic growth, increase profits); the possibility that inflation may get out of control and inflation rates may reach astronomical levels.

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.

This question was usually well done, most candidates were pretty clear about what cost-push inflation is. The question asks for causes, so more than one was advisable. In general, appropriate diagrams were drawn and labelled to show the impact of cost-push inflation. A minority of candidates confused cost-push inflation with demand-pull inflation. That of course, seriously undermined their response. Real-world examples were used but were often very generic in nature.  

To approach this question well, candidates needed to clearly consider deflation and inflation. It was necessary to consider something of the potential issues of each one before arriving at a reasoned conclusion. For some reason many candidates felt that they had to consider policies to moderate either situation. This was not asked for and simply cost these candidates valuable time. Japan's prior experience with deflation was a popular example used by many candidates.