GCE ‘A’ LEVEL H1 ECONOMICS (8819/01) NOVEMBER 2016

Section A

Answer all questions in this section

Question 1

The Impact of rising and falling prices

Inflation can be measured in several ways, with the most common being via the Consumer Price Index
(CPI). Fig. 1 below shows this measure of inflation for the UK during the period 2008-2014. It also shows
growth in ‘regular pay’ over the same period; regular pay measures average earnings, excluding
bonuses.

Source: The Guardian, 23 April 2014

Extract 1: Squeeze on living standards in UK

Economists have said that average UK living standards have fallen dramatically since the 2007-2008
financial crisis and recession, and will not reach pre-crisis levels before 2015. This is the case among
both high- and low-income groups, when cost of living is taken into account. The Institute for Fiscal
Studies (IFS) has calculated that a middle-income household’s real income in 2013-2014 was 6% below
its pre-crisis peak. Those in the top ten percent of income earners were worse off on average by 9%,
and those in the lowest ten percent by 2.4%. This reflected the fact that earnings had increased more
slowly than prices, whereas welfare benefits had largely kept pace with inflation. This had a greater
effect on the real income figures than the fact that prices of food and energy increased over the period
by more than the cost of living as a whole, even though food and energy account for a larger proportion
of the spending of poorer households. Overall, CPI rose by around 20% between 2008 and 2013, whilst
energy prices rose by 60% and food prices rose by 30% over the same period

Source: BBC News online, 31 January 2014

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Extract 2: Fear of price deflation in eurozone

Fears that the eurozone could move into outright price deflation were worsened yesterday as the
inflation rate in the currency area hit a new five-year low of 0.3%. ‘Each time inflation falls, the probability
rises that the Eurozone will fall into a deflation trap, where consumers postpone spending to wait for
lower prices and where debts rise in real terms’, said a spokesman for the Centre for Economics and
Business Research. Another expert argued that ‘The very low eurozone inflation reading for August
reinforces pressure on the European Central Bank (ECB) to consider further monetary stimulus on top
of what is already in place and planned, given that its inflation target is just below 2%.

Source: The Guardian, 30 August 2014

Extract 3: Price deflation and debts

If there is too much debt, people spend too much of their money on interest payments, and so reduce
spending on other things. Prices fall; inflation then turns into price deflation. What could be bad about
falling prices? Well, the debts don’t shrink, so you end up using more of your real income to service
them, and you consume even less.

This actually happened in the USA between 1929 and 1933, and since then, and particularly since
2008, economists and politicians have been terrified of it happening again. And in the Eurozone, their
fears are very much justified, with inflation there down to just 0.3% last month. In response the ECB
last week cut the interest rate to just 0.05%.

Source: The Guardian, 8 September 2014

Extract 4: Singapore inflation eases

Core inflation excludes changes in the prices of such items as cars and accommodation, which depend
particularly on government policies. The Monetary Authority of Singapore (MAS) expects it to be
between 2% and 3% in 2014. Domestic cost pressures, stemming particularly from the tight labour
market, will continue to remain as the primary source of inflation. Most economists believe that interest
rates are unlikely to be cut in the near future, and that the MAS will continue to rely on its policy of a
modest and gradual appreciation of the Singapore dollar.

Singapore’s headline inflation rate fell slightly in July, mainly on the basis of lower transport costs,
though a tight labour market is likely to keep core inflation high over the months ahead. The all-items
CPI rose by 1.2% year-on-year in July, compared with a rate of 1.8% in June, both being well below the
forecast of 2.1%. ‘This was largely the result of one-off supply-side factors causing lower inflation in
both transport and housing’, said a spokesman for Standard Chartered Bank in Singapore, ‘but I think
inflation in services continues to be a concern for the central bank, so that I would not expect any
change in the current policy stance of the MAS at its next review in October’.

Source: malaymailonline, 25 August 2014

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Questions

(a) Using the data from Fig. 1, summarise how the cost of living in the UK had changed over the
period 2008-2014. [3]

(b) Using Fig.1, explain how the data might be used to estimate changes in the average standard
of living in the UK over this period. [3]

(c) With reference to Extract 1:

(i) Suggest how the overall inflation rate over the period 2008-2013 is possible, given the rise
in food and energy prices over the same period. [2]

(ii) Comment on the suggestion that higher income earners suffered most over the period.
[4]

(d) With reference to Extracts 2 and 3, explain two reasons why governments tend to ‘fear’ a period
of price deflation. [4]

(e) With reference to Extracts 3 and 4, and using AS/AD analysis, explain why interest rates in the
Eurozone were cut in September 2014 but no such cut was expected in Singapore. [6]

[Total: 22]