2
YR 12 ECONOMICS
TEST
INFLATION
ECO2.1 Describe inflation and its causes and effects using economic models
Achievement
Describe inflation and its
causes and effects using
economic models.
1x Ad (describe inflation)
1x Ae (effects of inflation)
1x Ac (causes of inflation)
1x Am (economic models)
plus 3 other As or Ms
Merit
Explain inflation and its
causes and effects using
economic models.
Excellence
Fully explain inflation and its
causes and effects using
economic models.
any 3 of
1 x Md
1 x Me
1 x Mc
1 x Mm
Merit plus
2 Es
Note: A3, M3, A1, M1 do not
count towards this standard
Eco 3.4 Describe Aggregate Economic Activity
Describe the aggregate level of
economic activity and how the
aggregate demand and
aggregate supply model is
used.
Describe influences on New
Zealand’s aggregate economic
activity.
3 x A1s or better
Explain influences on
New Zealand’s
aggregate economic
activity.
As for A + 2 x M1s
ECO2.4 Process and analyse statistical data in relation to given economic issues
Process and present
statistical data, and carry
out an economic analysis.
2x A3 or better
Process and present
statistical data, and carry
out a full economic analysis.
1 x M3
.
2
For
Marker’s
Use only
QUESTION ONE
“Tomato prices have doubled on the local market in the last two weeks.”
Why might this situation not necessarily be classified as inflation?
1.
Idea that inflation is a weighted average of price increases so does not reflect individual
market price changes
Ad
QUESTION TWO
1.
(a) Calculate and fill in the Percentage change in CPI column.
Table One
Year
CPI
% change in
CPI
1
1000
-
2
1056
5.6
3
1079
2.1
4
1052
-2.5
5
1143
8.6
all
A3
Source: www.stats.govt.nz
(a) Calculate and fill in the Percentage change in CPI column
(b) Make a generalization about the rate of inflation from 1993-1997.
NZ has experienced unstable Inflation from years 1-4, the rate of Inflation has fluctuated from
yeas 1-5, Overall inflation has increased in NZ from years 1-5. NZ experienced a period of
Deflation in year 4.
A3
(c) Using the calculations in Table One, explain the ideas of disinflation and deflation.
Disinflation occurred from 1994 to 1995 as the rate of inflation fell
Deflation occurred between 1995 and 1996 as the rate is negative/prices fell
2.
The information calculated from Table Two allows us to calculate inflation using the CPI.
State two other measures of inflation.
1.
Any two of
2.
3.
Md
Producer Price Index /
Labour Cost Index
/
Capital Goods Index
Export Price Index
Explain at least TWO weaknesses or limitations of using the CPI to measure inflation.
Any two of
Ad
CPI is an average / only a sample of prices / wreights alter over time /
one-off price shocks distort the CPI / collection procedures change over time
Md
For
Marker’s
Use only
3
Table 2: Economy GDP – expenditure
4.
Quarter
Nominal $m
Real $m
Mar. 2007
42,105
33,881
Jun. 2007
42,838
33,754
Sep. 2007
42,087
32,835
Dec. 2007
43,617
34,390
a) Use Table 2 to describe the general trend in economic growth in 2007.
RGDP has increased over the 2007 calendar year despite a falling off in the middle quarters. Both
Nominal & RGDP have increased over the 2007 calendar year. The rate of growth (% change in
RGDP) fell off the in the middle part of the year.
b) Explain the interconnection (link) between table 2 ( Real GDP) and table 1 (CPI)
RGDP is nominal GDP adjusted for inflation (price level increases) using the CPI. If RGDP is
increasing then the economy has actually produced more, where as if nominal GDP is increasing more
than RGDP the increase may be just due to an increase in the value of production and production may
have fallen
A3
M3
QUESTION THREE
(a)
Stage of the Business Cycle
A
Boom/Peak
B
Recession/Downturn
C
Depression/Trough
D
Recovery Upswing
(b) Identify the stage of the business cycle that would disinflation would occur? Explain your
choice.
B or Recession/Downturn - Idea that as growth slows the rate of inflation/price rises fall due to a fall off
in demand Recession / downswing / contraction / depression stage because consumption / spending /
investment decrease and AD / economic activity will be declining
OR economy will have excess capacity / idle resources due to AD / economic activity declining.
Any
3
Am
Am/
Mm
QUESTION FOUR
M : the money supply
V: the velocity of circulation
P: the price level
Any
3
Am
Q: the real output
Explain the difference between the crude and sophisticated Quantity Theory of Money.
Crude – Q & V constant – increase in M lead to increase in P
Sophisticated all variable but V relatively constant, while increase in M can lead to increase in P, there
are other variables – ie Q could also increase in return.
Am
/
Mm
4
1.
State at what stage of the business cycle Q is likely to be relatively constant. Explain your
answer
Peak/Boom. At full capacity so no or limited spare resources. Q cannot be increased without a large
increase in P.
Mm
Q4Am
Mm
x
2=
E
QUESTION FIVE
(a) Identify for each of the following whether it is cost push or demand pull Inflation.
(i) Cost push
(ii) Demand Pull
(iii)
Cost Push
Any
2Ac
(b) Explain your answer to ii).
Increased retail sales means an increase in private consumption spending, all other factors remaining
constant this would lead to an increase in overall aggregate demand which will increase output but at a
higher price level – hence inflation. Or the increased sales is as a result of increased consumption
spending. Overall production or output will increase in response to the increased demand but only at a
higher price level – inflation.
QUESTIONSIX
(a)
See Appendix One. – Fully Labeled
(b)
See Appendix Two – Must show increase in PL- Inflation, AD shifts more than AS (full labels)
(c)
AS curve:
Increase – increased migration will increase supply of labour – forcing down wages, COP fall –
Aggregate Supply Increases
AD curve:
Increase – consumption spending increase with increased demand for food and housing by new
migrants – will increase Aggregate Demand
(d)
increase in immigration has impacted on inflation and growth.
Overall slight increase inflation – price level will rise, output will also increase, as output also measures
RGDP then growth will occur as increase in RGDP is a measure of growth.
Mc
Am
Mm
Ac/
Mc
1
=
2
=
exp
A
exp
M
Mc
A
Mm/
Mc
x 2
= E
5
For
Marker’s
Use only
QUESTION SEVEN
1.
Identify two negative impacts of inflation on households.
(a)
TWO of:
(b)
Income inequality grows / savings discouraged / fiscal drag / budget or planning problems /
Ae/
Me
(c) decrease in purchasing power / lower real incomes / rising cost of borrowing Described – Ae, Described & Explained - Me
2.
Identify two negative impacts of inflation on firms.
(a)
TWO of:
(b)
Rising costs (wages, materials, interest rates) / capital replacement difficult / planning problems /
(c)
exports less competitive / less investment / rising cost of borrowing
Described – Ae, Described & Explained - Me
Ae/
Me
E=
2Me
QUESTION EIGHT
1.
a) AD decreases – shift left, decrease in PL & Y – new pl/y labeled & arrows
M1
b) Which type of policy includes actions by the Reserve Bank that affect interest rates or the
money supply?
Monetary Policy
A1
c) The main objective of this policy is to maintain price stability. How is price stability currently
defined in the Policy Target Agreement?
1-3% inflation rate (on average over the medium term)
A1
d) a) Describe what is meant by the OCR and fully explain the link between the OCR &
Market Interest Rates (r)
OCR = Official Cash Rate – rate at which banks borrow from RBNZ on settlement cash deposits +.25% and
lend to the RBNZ at -.25%
Idea – relates to a banks funding costs – so an increase or decrease is passed on to market rates. So market
interest rates are usually closely aligned. – for E must use terms – settlement cash deposits – bank lending
costs - +/- .25%
b)
Fully explain with reference to Consumption Spending, Investment Spending and Net
Exports the effect of a fall in the OCR:
Consumption
Investment
Increases – lending costs fall – debt servicing/borrowing etc,
credit less expensive, opportunity cost of saving lower – or less
incentive to save.
Increase - Less expensive to Invest- borrowing costs fall, cost of
investment less than expected returns – so more incentive to invest
A1/
M1/
E1
Just
effect
= A
Explai
ned =
M
A1/
M1
Each
E1 –
all 3
effect
s
explain
6
Net Exports Increase – if NZ interest rates are relatively lower than other countries. Idea of capital
outflows – investment decreases – d for Nz$ decreases
c)
Many prominent economists and politicians have criticised the OCR as a monetary policy
tool. What are the limitations of the OCR as a tool in achieving price stability & growth?
Justify your answer.
Idea that banks source most funds overseas and must pay overseas price for credit.
Appendix 1
Appendix 2
For
Marker’s
Use
E1