Causes of Inflation | Edexcel Economics AS

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Sources for use with Section C The US economy

Annual rate of inflation, as measured by the consumer price index (CPI), January 2020 to December 2023

Extract A Rate of inflation Between 2021 and 2023 the US economy experienced a relatively high rate of inflation. The main causes of this were disruptions to the supply chain as a result of the global health crisis of 2020–2022, rising global prices of energy and food in 2021–2022, and high wage growth in 2022–2023. The country’s central bank, the Federal Reserve (Fed), forecast that the rate of inflation would return to the inflation target of 2% in 2024. It indicated that energy prices and food prices had started to fall. It expected slower wage growth as the rate of inflation decreased. The Fed believed that the rate of inflation would fall without causing a significant rise in the rate of unemployment. It forecast that the rate of unemployment would average 4% in 2024, a little higher than the 50-year low of 3.6% in 2023.

Extract B Economic growth The USA’s rate of economic growth increased from 1.9% in 2022 to 2.5% in 2023. High consumer spending on services, such as hotels and travel, was the major factor that contributed to economic growth. Government policy also played an important role in increasing the growth rate. The US Government spent $1 trillion on infrastructure projects including the building of roads, airports and bridges. These projects resulted in the creation of new jobs. Economists forecast that the rate of increase in economic growth was likely to slow down in 2024. This is because there had been a series of interest rate increases by the Fed. This resulted in the country’s base rate of interest increasing from 0.25% in March 2022 to a record high of 5.5% in July 2023. In addition, consumers in the USA were relying more on credit cards to finance their spending. It was predicted that more consumers would find it difficult to pay interest on their mortgages, car loans and credit cards. Consumers were also struggling to finance the rising costs of car insurance, medical care and childcare. Although some economists expected a recession in 2024, many were optimistic that the US economy would stabilise without causing any major job losses.

With reference to Figure 1 and the first paragraph of Extract A, examine two causes of the relatively high rate of inflation in the USA.

Knowledge 2, Application 2, Analysis 2, Evaluation 2

Quantitative skills assessed:

QS2: Calculate, use and understand percentages, percentage changes and percentage point changes.

QS9: Interpret, apply and analyse information in written, graphical, tabular and numerical forms.

QS10: Distinguish between changes in the level of a variable, and the rate of change.

Knowledge and analysis

Up to 2 marks for identifying two causes and one mark for each linked explanation, e.g.:

- Disruptions to the supply chain (1K) creates shortages of goods and services, therefore causing cost-push inflation (this may be shown diagrammatically) (1AN)

- Rising energy/food prices (1K) increases cost of imports, shifting SRAS to the left (this may be shown diagrammatically) (1AN)

- High wage growth (1K) increases firms' production costs, who pass these on to the consumers in the form of higher prices / consumers spend more resulting in demand-pull inflation (this may be shown diagrammatically) (1AN)

Application

Up to 2 marks for application to Figure 1, e.g.:

- The rate of inflation increased from 1.4% in January 2021 (1) to 6\% in January 2022 (1)

- Between January 2021 and January 2022 the rate of inflation increased by 4.6 (1) percentage points (1)

Evaluation

Up to 2 marks for evaluative comments ( 1+1 or 2+0 ), e.g.:

- The magnitude of the increase in the rate of inflation is high (1) so it is likely to be a combination of causes that have increased inflation (1)

- Cost-push inflation is likely to be serious/significant (1) as the Fed will have limited tools to control it (1)

- Energy and food prices have started to fall/their prices are highly volatile (1) so inflation may not remain high in the long-run (1)

- Slower wage growth is likely to reduce the rate of inflation in the future (1) so inflation will only be high in the short-run (1)

- Significance of factors change over time (1) global health crisis of 2020-2022 followed by rising energy and food prices in 2021-2022 and then by wage growth 2022-2023 (1)

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2.3.1.2e - Causes of inflation: • demand-pull • cost-push • excessive growth of money supply question 1