Explain the term ‘inflation rate’ (4 marks)
• Inflation rate = percentage increase in average prices over time
• Measured using CPI (Consumer Prices Index)
• Shows how fast prices are rising
Figure 1 context
• Around 4–5% in 2008
• Around 0% in 2015
Assess the likely impact of an increase in real wages on the UK economy (10 marks)
Point
• Higher real wages increase aggregate demand (AD)
Explanation
• Real wages rise when wages increase faster than inflation
• People have more spending power
Analysis
• Higher income → more consumer spending
• Consumption increases AD
• AD shifts right
• Leads to higher GDP and employment
Context
• Figure 1: after 2016 wages rose faster than inflation
However
• Higher wages increase firms’ costs
• May cause cost-push inflation or lower employment
Two characteristics of a recession (6 marks)
- Falling economic growth (GDP)
• Recession = two quarters of negative GDP growth
• Figure 2: GDP fell to around –2% in 2008–2009 - Higher unemployment
• Financial crisis reduced credit and spending
• Firms produced less and laid off workers
Fall in exchange rate increases inflation (5 marks
• Depreciation of the pound makes imports more expensive
• UK imports many goods and raw materials
• Firms face higher production costs
• Firms raise prices
• Leads to cost-push inflation
Factors MPC considers when changing interest rates (15 marks) - inflation
Point
• MPC considers inflation
Explanation
• If inflation is above the 2% target, interest rates may rise
Analysis
• Higher interest rates → borrowing more expensive
• Less spending and investment
• AD falls
• Helps reduce inflation
Context
• Extract A: inflation rose after fall in pound
• MPC increased rates in 2017 and 2018
However
• Higher interest rates may slow economic growth
Factors MPC considers when changing interest rates (15 marks) - economic growth / unemployment
Point
• MPC also considers economic growth and unemployment
Explanation
• If the economy is weak, interest rates may fall
Analysis
• Lower interest rates → cheaper borrowing
• More spending and investment
• AD rises
• Leads to higher growth and employment
Context
• After 2008 financial crisis
• Rates cut from 5.25% to 0.5%
• Unemployment reached 8.5%
However
• Very low interest rates can increase household debt
