2.1.2 Inflation Quiz: Pearson Edexcel Economics A, Unit 2

The 20 questions

1. Inflation is best defined as:

   • a fall in the rate of increase of prices while prices still rise
   • a sustained fall in the general price level over time
   • a sustained rise in the general price level over time
   • a rise in the price of one particular good, such as petrol

2. Deflation refers to:

   • a rise in the value of sterling against other currencies
   • a fall in the rate of inflation while prices still rise
   • a sustained fall in the general price level
   • a rise in the price level caused by excess demand

3. Disinflation means:

   • a permanent rise in interest rates by the central bank
   • a fall in the general price level
   • a fall in the rate of inflation while the price level is still rising
   • a rise in the rate of inflation caused by higher wage settlements

4. The UK's Consumer Prices Index (CPI) is calculated by:

   • averaging the prices of only the goods the government buys each year, so public spending is the sole basis for the price level
   • recording the price of a fixed set of imported goods only, ignoring domestic goods, services and changes in household spending
   • tracking the prices of a representative basket of goods and services, weighted by their share of household spending
   • measuring the change in average wages across all sectors, so the index reflects what workers earn rather than what they pay

5. Compared with the CPI, the Retail Prices Index (RPI):

   • excludes all housing costs and so is always lower than the CPI
   • includes housing costs such as mortgage interest payments and council tax
   • is calculated using only the prices of goods bought by pensioners
   • covers only households in the top income decile of the population

6. A limitation of the CPI as a measure of the cost of living is that it:

   • includes all asset prices, such as share prices and house prices, so it overstates the cost of living for households without assets
   • measures prices at wholesale level only and ignores retail prices, so it misses the price changes that shoppers face in the high street
   • uses average spending weights, so it may not reflect the experience of particular groups such as pensioners
   • is calculated only once every decade and so is always out of date, which means it cannot be used to compare prices across years

7. Demand-pull inflation is caused by:

   • aggregate demand growing faster than aggregate supply in an economy operating near full capacity
   • a fall in the rate of economic growth that lowers real output
   • a fall in the money supply that reduces spending in the economy
   • a rise in the costs of raw materials that shifts short-run aggregate supply to the left

8. Cost-push inflation most directly results from:

   • a rise in aggregate demand caused by increased government spending on infrastructure
   • an increase in the money supply in an economy already at full employment
   • a fall in short-run aggregate supply caused by higher costs of production such as energy or wages
   • an increase in household saving that reduces consumer spending

9. The quantity theory of money suggests that inflation is caused by:

   • a persistent rise in the unemployment rate across the economy, which reduces firms' costs and so lowers the general price level
   • an increase in the current account surplus, which always reduces the money supply and so lowers the general price level
   • growth of the money supply faster than real output, with velocity of circulation stable
   • real output growing faster than the money supply, which pushes prices down and creates persistent deflation in most years

10. Unexpected inflation tends to harm which group most?

    • governments with large fixed-rate debts in nominal terms
    • borrowers with fixed-rate debts, whose real repayments fall
    • firms holding large stocks of real assets such as land
    • savers holding cash or fixed-interest savings, whose real value falls

11. Which is an effect of high and volatile inflation on firms?

    • uncertainty about future prices makes investment planning harder and may reduce investment
    • it removes the need for firms to change their prices at all
    • it always raises profits because revenues rise faster than costs
    • it makes exports cheaper, so exporters always gain from higher inflation

12. The CPI rises from 110 to 115.5 over a year. What is the annual rate of inflation?

    • 0.5%
    • 5%
    • 10.5%
    • 4.5%

13. A price index rises from 200 to 210 in year 1 and from 210 to 220 in year 2. What is the inflation rate in year 2, to one decimal place?

    • 4.8%
    • 0.5%
    • 10%
    • 9.5%

14. Nominal wages rise by 4% while the CPI rises by 6%. Which is the approximate change in real wages?

    • +2%
    • +10%
    • -10%
    • -1.9%

15. Nominal interest rates are 5% and inflation is 3%. What is the approximate real interest rate?

    • about 2%
    • 15%
    • 8%
    • -2%

16. A rise in the price of imported oil raises UK production costs and so consumer prices. Which type of inflation is this?

    • hyperinflation caused by printing money
    • demand-pull inflation
    • cost-push inflation
    • deflation caused by falling output

17. A central bank keeps interest rates very low while the economy grows above its trend rate. Which inflation outcome is most likely?

    • demand-pull inflation, as aggregate demand grows faster than aggregate supply
    • disinflation with no change in the price level over time
    • deflation, because low rates reduce the money supply in the economy
    • cost-push inflation alone, because tax rates have risen

18. Why might the CPI overstate the true rise in the cost of living for some households?

    • The CPI includes only imported goods in its basket, so it overstates domestic costs of living because it ignores UK-made goods
    • The CPI excludes all food and fuel from its basket, so it understates the rise in household costs and flatters living standards
    • Quality gains and switches to cheaper goods are poorly captured, so measured price rises can exceed the true cost-of-living change
    • The CPI counts savings accounts as spending on consumer goods, so it understates the price rises households face on necessities

19. Inflation falls from 6% to 3% over a year while prices still rise. Which best describes this?

    • deflation, because the price level is falling as the economy slows down and households reduce their spending on everyday goods
    • cost-push inflation caused by rising unemployment, which pushes up the costs of firms and raises the general price level
    • disinflation, because inflation is still positive but its rate has fallen
    • stagflation caused by a fall in real output, with rising unemployment and falling prices across the whole economy at once

20. Why do inflation expectations matter for wage bargaining?

    • Expectations of inflation cause the CPI to fall in the following period, because workers who expect higher prices cut their spending
    • Workers' expectations have no effect on pay because government sets all wages, fixing every settlement at the start of each year
    • Higher expected inflation can lead workers to demand bigger nominal pay rises, which feed through into higher prices in a wage-price spiral
    • Expected inflation eliminates the real value of nominal wages entirely, so workers can never gain from pay rises above the price level

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