Essay Question January 2013 01 02 03 04
1. An economic cycle is when GDP growth fluctuates around the trend (or underlying) economic growth. A boom occurs when real national output is rising at a faster rate than the trend rate of growth. A slowdown occurs when the rate of growth decelerates – but national output is still rising. A recession occurs when there is a fall in real GDP for two or more consecutive quarters (6 months or more). A slump or a depression is a prolonged and deep recession leading to a significant fall in output and average living standards. A depression is where real GDP falls by more than 10% from the peak of the cycle to the trough. This occurs when real GDP picks ...view middle of the document...
’ Demand pull inflation is ‘relating to or denoting inflation caused by an excess of demand over supply.’ However, cost-push inflation is ‘relating to or denoting inflation caused by increased labour or raw material costs.’
Extract B, lines 1 and 2 states that after a “period of prolonged growth, known as the NICE (non-inflationary, constant expansion) decade, in 2008 the UK entered the worst recession it has experienced since World War Two.” This suggests that even after a period of sustained growth, it has not been accompanied by rising inflation.
Extract C states that “If inflation is above target when the recovery is weak, unemployment is high and there is plenty of spare capacity in the economy, what will happen when the pace of the recovery quickens? A further increase in inflation is inevitable, or is it? At present, wages are only increasing slowly and there is little evidence to suggest that people expect the current above-target rate of inflation to continue.” This suggests that the rise in inflation may only be temporary.
Demand pull inflation occurs when aggregate demand is growing at an unsustainable rate leading to increased pressure on scarce resources and a positive output gap. When there is excess demand, producers can raise their prices and achieve bigger profit margins. Demand-pull inflation becomes a threat when an economy has experienced a boom with GDP rising faster than the long-run trend growth of potential GDP. Demand-pull inflation is likely when there is full employment of resources and SRAS is inelastic.
The main causes of Demand-Pull Inflation are, firstly, a depreciation of the exchange rate increases the price of imports and reduces the foreign price of a country's exports. If consumers buy fewer imports, while exports grow, AD in will rise – and there may be a multiplier effect on the level of demand and output. Secondly, higher demand from a fiscal stimulus e.g. lower direct or indirect taxes or higher government spending. If direct taxes are reduced, consumers have more disposable income causing demand to rise. Higher government spending and increased borrowing creates extra demand in the circular flow. Thirdly, monetary stimulus to the economy. A fall in interest rates may stimulate too much demand – for example in raising demand for loans or in leading to house price inflation. Monetarist economists believe that inflation is caused...