AQA A-level Economics: Inflation and deflation (7136) – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – examination boards hold copyright in their own papers. Use these alongside the official past papers from your board or school.

These questions cover inflation, deflation and disinflation, demand-pull and cost-push, MV = PQ, expectations, consequences and external influences for AQA A-level Economics (7136), specification version 1.3, section 4.2.3.3 (3.2.3.3 on the AQA website). Every country and figure is invented and illustrative. Read the study guide and revision notes first. Course pages: AQA A-level Economics hub, checklist and free diagnostics. Show your working.

Questions

1. In Country D the price index was 96.0 last year and is 98.4 this year. Inflation the year before was 4.0%.

(a) Calculate the rate of inflation this year. [2] (b) Explain whether this is deflation or disinflation. [2]

2. In Country E the money supply is 600, velocity of circulation is 3 and real output is 900.

(a) Calculate the price level using MV = PQ. [2] (b) The money supply rises to 660, with V and Q unchanged. Calculate the percentage change in the price level. [2] (c) In another year, the money supply grows 5%, V is constant and real output grows 2%. Calculate, to 1 decimal place, the percentage change in the price level. [2]

3. Workers in Country A win a pay rise of 7% while prices rise 3.5%.

(a) Find the percentage rise in real pay, giving your answer to 1 decimal place. [2] (b) Explain how workers’ expectations of inflation can make inflation rise. [2]

4. A household holds 50,000 in savings that earn no interest. Inflation is 3% a year for 4 years.

(a) Calculate the purchasing power of the savings after 4 years in today’s prices, to the nearest whole unit. [2] (b) Explain two ways in which inflation might affect individuals other than savers. [4]

5. In Country G fuel has a weight of 5% in the price index. World fuel prices rise 15% in dollars.

(a) Calculate the direct contribution to inflation. [2] (b) Explain two reasons why the total effect on inflation may differ from your answer. [3]

6. Explain, using AD/AS analysis, how demand-pull inflation differs from cost-push inflation in its effect on real output. [6]

7. A borrower in Country H owes a fixed 20,000. The price level falls 3% a year for 2 years.

(a) Calculate the percentage rise in the goods needed to repay the debt, to 1 decimal place. [2] (b) Explain why falling prices might reduce consumer spending. [4]

8. Imported goods have a weight of 25% in Country J’s price index. Import prices rise 10% because its trading partner has an inflation spike.

(a) Calculate the direct effect on inflation. [2] (b) Explain how faster growth in a major trading partner could affect Country J’s inflation. [3]

9. Country K’s government cuts spending and raises taxes. Inflation falls from 7% to 5% to 3% over three years from a starting index of 100.

(a) Calculate the index at the end of year 3, to 2 decimal places. [2] (b) Explain whether the policy has caused deflation. [2]

10. Evaluate the view that the Quantity Theory of Money shows that inflation is caused only by excess growth in the money supply. [8]

11. Discuss whether deflation is always harmful to an economy. [8]

Answers

1. (a) Change = 98.4 − 96.0 = 2.4 [1]. 2.4 / 96.0 × 100 = 2.5% [1] [2] (b) Inflation fell from 4.0% to 2.5% [1], but the index still rises, so prices rise more slowly: disinflation, not deflation [1] [2] Examiner insight: A one-word label with no reference to the figures is rarely enough; quote both inflation rates and say that prices are still rising.

2. (a) MV = 600 × 3 = 1,800 [1]. P = 1,800 / 900 = 2.0 [1] [2] (b) New MV = 660 × 3 = 1,980, so P = 1,980 / 900 = 2.2 [1]. (2.2 − 2.0) / 2.0 = +10% [1] [2] (c) %ΔP: 1.05 / 1.02 = 1.0294 [1], so about 2.9% [1] [2] Examiner insight: Show the new value of MV before dividing; a bare percentage cannot show which step went wrong. Say which variables you are holding constant.

3. (a) Real pay factor = 1.07 / 1.035 [1] = 1.0338, so a rise of 3.4% [1] [2] (b) If workers expect inflation to be high they bargain for larger pay rises [1], raising firms’ costs, so firms raise prices and the expectation is confirmed [1] [2] Examiner insight: Explanations score for a chain of reasons; naming “expectations” without linking pay claims to costs and prices is a statement, not an explanation.

4. (a) Real value = 50,000 / 1.03⁴ [1] = 44,424.35, so 44,424 [1] [2] (b) Two chains of 2 each: fixed-income recipients, such as pensioners, lose because their money buys less [1] as their income is unchanged [1]; borrowers with fixed-rate debt gain because they repay in money worth less [1] so the real burden falls [1] [4] Examiner insight: Name who is affected and the direction, then give the reason. Consequences stated as bare lists score less than two developed points.

5. (a) 5% × 15% [1] = 0.75 percentage points [1] [2] (b) Firms using fuel face higher costs and pass some on, so indirect effects add to inflation [1]; the exchange rate may rise or fall, changing the domestic price of dollar-priced fuel [1]; firms may absorb the rise in margins, or the rise may be temporary [1] [3] Examiner insight: A direct-effect calculation is a starting point; the explanation needs reasons that raise or lower it, not a repetition of the calculation.

6. Demand-pull follows a rise in AD [1]; the AD curve shifts right along SRAS, so the price level rises [1] and real output rises [1]. Cost-push follows a rise in costs [1], so SRAS shifts left, the price level rises and real output falls [1]. Conclusion: the key difference is that output rises in one case and falls in the other [1] [6] Examiner insight: Name the curve that shifts and the direction, and say what happens to real output. Describing both as “prices go up” shows no difference.

7. (a) Price level after 2 years = 0.97² = 0.9409 [1]. 1 / 0.9409 − 1 = 6.28%, so 6.3% [1] [2] (b) Consumers expect lower prices, so delay purchases [1] which reduces AD [1]; the real value of debt rises, so debtors cut spending to repay [1]; falling profits lead to lower pay or job losses, reducing incomes [1] [4] Examiner insight: Link each reason to AD. Describing debt without saying it leads to lower spending leaves the chain unfinished.

8. (a) 25% × 10% [1] = 2.5 percentage points [1] [2] (b) Faster growth abroad raises demand for exports, so AD rises [1]; with little spare capacity, firms raise prices (demand-pull) [1]; the exchange rate may rise, which lowers import prices and partly offsets this [1] [3] Examiner insight: A one-way argument limits the response. A counter-effect such as the exchange rate gains credit when it is linked to the outcome.

9. (a) 100 × 1.07 × 1.05 × 1.03 [1] = 115.72 [1] [2] (b) The index rises each year [1], so the policy reduced AD and caused disinflation, not deflation [1] [2] Examiner insight: Use the figures: an index above 100 and still rising shows prices have not fallen.

10. Definition: MV = PQ with V stable and Q fixed, so P changes with M [1]. Support: if Q is at full employment and V is constant, extra money raises P in proportion, as with M 400 to 440 giving P 2.0 to 2.2 [1] with the rise in P matching the rise in M [1]. Evaluation: V can change in a recession [1]; Q can rise in the short run when money rises [1]; cost-push shocks, such as dearer commodities, raise prices without money growth first [1]; money may respond to prices rather than cause them [1]. Judgement: the theory is most relevant over the long run and for sustained, high inflation, while short-run shocks need other explanations [1] [8] Examiner insight: Strong answers use the equation to build the argument, then test the assumptions. Reciting the equation without evaluating V and Q stays at description.

11. Harmful case: delayed spending cuts AD [1]; real debt rises and bad debts follow [1]; falling profits reduce investment and employment [1]; real interest rates rise as nominal rates cannot fall far below zero [1]. Not harmful: if caused by productivity gains that shift LRAS right, prices fall while output grows (benign deflation) [1] with no loss of output; savers gain purchasing power [1]. Judgement: depends on the cause, size and duration, and on debt levels [1]; deflation from falling AD is the damaging kind [1] [8] Examiner insight: A one-sided answer leaves the judgement unsupported. Separate benign from malign deflation and make your judgement depend on the cause.

Where marks are usually lost

• Writing “deflation” when the index is still rising.
• Giving a percentage change without showing MV or the new price level.
• Failing to state that V and Q are held constant when applying the Quantity Theory.
• Using the nominal figure when real pay or real value is asked.
• Stating consequences without saying who is affected and why.
• Leaving out the exchange rate when a commodity is priced in a foreign currency.
• Showing a cost-push shift as a change in AD.
• Ending an evaluation with a summary and no judgement.

Next steps

• Re-read the revision notes and the study guide.
• Visit the AQA A-level Economics hub and tick off topics on the checklist.
• Take the free 10-minute diagnostics.
• Book a free trial class.

Official syllabus

Source: the A-level Economics specification published by AQA (version 1.3, 29 June 2022), content section 4.2.3.3.