Explain how rising commodity prices and wages might lead to cost-push inflation.

Discuss the possible consequences of deflation for an economy.

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, (primary) commodity
• AD/AS diagram showing a shift of the short-run aggregate supply curve to the left and higher average price level
• an explanation of how cost-push inflation is caused by the increase in the costs of production due to the rising commodity prices and wages
• examples of countries where cost-push inflation has taken place.

NB A maximum of [6] should be awarded if a candidate has only explained the effect of rising commodity prices OR rising wages.

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

Answers may include:

• definition of deflation
• AD/AS diagram(s) showing either AD or AS shifting and a lower average price level
• an explanation of possible consequences of deflation such as deflationary spiral with high levels of cyclical unemployment and/or bankruptcies due to rising real value of debt
• examples of countries that have experienced deflation
• synthesis or evaluation (discuss).

Discussion may include: consideration of the extent to which the consequences of deflation depend on its causes; consideration of the effect of deflation on different stakeholders.

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

Most candidates were able to draw an AD/AS model and explain that cost-push inflation is caused by an increase in the cost of production but their answers would be improved if they could further support their explanations by an appropriate historical example.

The great majority of candidates understood the concept of deflation but too many candidates focused their answers on the causes of deflation instead of on the consequences of deflation. Also, candidates often spent a lot of time discussing the consequences of expansionary fiscal and monetary policies. Their answers could be significantly improved if they had focused on discussing negative consequences that can be directly attributed to the falling average price level.