Inflation — A-Level Economics Revision

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What is Inflation?

Inflation is the sustained increase in the general price level of goods and services in an economy over a period of time, leading to a fall in the purchasing power of money. The main measure in the UK is the Consumer Price Index (CPI), which tracks the price of a representative basket of goods and services. The two main types are demand-pull inflation, caused by excess aggregate demand, and cost-push inflation, caused by rising costs of production.

Board notes: A core topic for all A-Level boards (AQA, Edexcel, OCR). Students must be able to distinguish between demand-pull and cost-push inflation using AD/AS diagrams. AQA and Edexcel often require an understanding of the quantity theory of money and the trade-off between inflation and unemployment (the Phillips Curve). OCR places emphasis on the consequences of inflation for different economic agents.

Worked example

Common mistakes

• 1Confusing inflation with a one-off price increase. Inflation refers to a *sustained* increase in the general price level, not just a temporary price hike in a single product or sector.
• 2Thinking that a low rate of inflation (e.g., 2%) is the same as prices falling. A positive inflation rate means prices are still rising, just at a slower pace. Prices only fall during deflation, which is a negative inflation rate.
• 3Assuming that inflation is always bad for everyone. While it erodes savings and can hit those on fixed incomes, it can benefit borrowers (as the real value of their debt falls) and can make it easier for firms to adjust real wages downwards.

Inflation exam questions

Exam-style questions for Inflation with mark-scheme style solutions and timing practice. Aligned to AQA, Edexcel and OCR specifications.

Frequently asked questions

• What causes demand-pull inflation?

  Demand-pull inflation occurs when aggregate demand grows faster than aggregate supply. This can be caused by factors such as lower interest rates encouraging borrowing and spending, cuts in income tax boosting consumption, or a sharp increase in government spending.

• What is the quantity theory of money?

  The quantity theory of money, often associated with monetarists, states that there is a direct relationship between the amount of money in an economy and the price level. The equation MV = PQ suggests that if the money supply (M) grows faster than real output (Q), assuming velocity (V) is stable, it will lead to inflation (a rise in P).