4.2.3.3 Inflation and deflation Quiz: AQA Economics, Unit 2

The 20 questions

1. What is deflation?

   • A fall in the rate of inflation
   • A rise in real GDP
   • A rise in the general price level
   • A fall in the general price level

2. What is disinflation?

   • A fall in the general price level, which is the same as deflation and means that inflation has become negative for the year
   • A fall in the rate of inflation, while prices are still rising
   • A rise in unemployment caused by lower prices
   • A rise in the rate of inflation

3. What is demand-pull inflation?

   • Inflation caused by a fall in the money supply
   • Inflation caused by aggregate demand growing faster than aggregate supply
   • Inflation caused by a rise in the costs of production for firms, which pushes up prices as firms pass higher costs on to buyers
   • Inflation caused by a rise in the exchange rate

4. What is cost-push inflation?

   • Inflation caused by an increase in the number of firms
   • Inflation caused by lower interest rates on savings
   • Inflation caused by a fall in aggregate demand, which leads firms to raise prices in order to protect their profit margins
   • Inflation caused by an increase in the costs of production, such as wages or raw materials

5. In Fisher's equation of exchange MV = PQ, what does V represent?

   • The velocity of circulation, the average number of times money changes hands in a year
   • The value of the exchange rate
   • The volume of trade between countries
   • The variability of prices in the economy, which measures how far individual prices move away from the average price level each year

6. What does the Quantity Theory of Money suggest in the monetarist model?

   • In the long run, changes in the money supply feed proportionally into changes in the price level
   • Changes in the money supply have no effect on the price level in any period, because prices are set only by the level of output
   • Prices are set by the government regardless of the money supply
   • The price level depends only on the exchange rate in the long run

7. Which of the following is a consequence of inflation for savers?

   • Their savings always rise in real terms as prices rise
   • Their savings are protected because banks always raise interest rates by the inflation rate
   • The real value of their savings falls if interest paid is below the inflation rate
   • They are unaffected because inflation affects only borrowers

8. In the equation MV = PQ, the money supply is 200 billion pounds, V is 4 and real output Q is 400 billion. What is the price level P?

   • 2
   • 800
   • 4
   • 200

9. Using the quantity theory, the money supply rises by 10 per cent while V and Q are constant. What happens to the price level?

   • It stays the same
   • It rises by 20 per cent
   • It rises by 5 per cent
   • It rises by 10 per cent

10. Inflation is 5 per cent and nominal wages rise by 3 per cent. Approximately what happens to real wages?

    • They rise by about 3 per cent
    • They fall by about 2 per cent
    • They rise by about 8 per cent
    • They stay the same

11. A sharp rise in world commodity prices raises the costs of UK producers. How does this affect domestic inflation?

    • It only causes deflation in the UK
    • It is a source of cost-push inflation in the UK
    • It reduces UK inflation through lower costs for all firms
    • It has no effect because UK prices are set in London

12. A depreciation of the pound raises the sterling price of imported goods. What is the likely effect on UK inflation?

    • It tends to lower UK inflation, because imports become cheaper
    • It tends to raise UK inflation through higher import prices
    • It causes deflation, because firms will reduce their prices
    • It has no effect on inflation, because imports are a small share of spending

13. Workers expect inflation to rise and bargain for higher wages, which in turn pushes prices up. What is this an example of?

    • Deflation caused by a rise in the money supply
    • Expectations effects on the price level, which can be self-fulfilling
    • Disinflation caused by an increase in productivity
    • Demand-pull inflation caused by a fall in aggregate demand, which pulls prices up as firms compete for a smaller pool of buyers

14. What is a consequence of inflation for firms, through the cost of changing prices?

    • Menu costs, the costs of frequently changing prices and catalogues, rise
    • Firms are able to avoid all risks of price changes by holding prices fixed for many years regardless of the costs they face
    • Costs of production fall as the price level rises
    • Firms no longer need to change their prices at all

15. Which is a consequence of deflation for consumers?

    • They always repay their debts more easily in real terms
    • They are unaffected, because deflation has no effect on spending and households always keep their spending at the same level
    • They always spend more because prices are falling
    • They may delay spending because prices are expected to fall further

16. Why does deflation increase the real burden of debt?

    • Falling prices reduce the interest rate on all loans to zero
    • Falling prices raise the real value of debt, so debtors must repay more in real terms
    • Deflation has no effect on the real value of debt
    • Falling prices reduce the nominal value of all debts automatically, so borrowers repay less money in cash terms each year

17. Why might deflationary policies not necessarily result in deflation?

    • Deflationary policies only affect the exchange rate, not the price level
    • Deflationary policies raise the money supply, which prevents deflation
    • Reducing aggregate demand may only slow inflation, so the price level can keep rising at a lower rate
    • Reducing aggregate demand always raises prices, so deflation is impossible in every economy, whatever policy the government follows

18. Why does using Q in the Fisher equation avoid problems with intermediate transactions?

    • PQ then represents the money supply, so it can be measured directly
    • PQ then represents nominal national income, which excludes double counting of intermediate goods
    • PQ then represents the total value of all transactions, including intermediate goods, which avoids any need for real output data
    • PQ then includes only imports and exports, so it is easy to measure

19. Inflation rises from 2 per cent to 4 per cent while unemployment is unchanged. Which explanation is most consistent with this change?

    • A rise in productivity that lowers costs and reduces the price level
    • A fall in aggregate demand that lowers inflation and unemployment together, because firms cut both prices and hiring in the same period
    • A fall in the money supply that lowers the price level
    • A rise in expectations of inflation or a rise in costs, pushing up prices without a change in unemployment

20. Is deflation always harmful for an economy?

    • Yes, deflation only harms the government and its tax revenues, and never affects households, firms or workers in any way at all
    • No, falling prices from supply-side improvements can raise real incomes, but deflation caused by weak demand can cause harm
    • Yes, deflation is always harmful in every circumstance without exception
    • No, deflation always improves real incomes whatever its cause

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