From inflation to deflation For some time, many central banks have tried to achieve a target inflation rate of about 2%. A small and steady rise in the price level can bring a number of benefits to an economy. For central banks and governments, the problem used to be stopping the inflation rate from going above the target rate while keeping the unemployment rate low. Now the problem has changed, and the risk is that inflation will fall below this target rate. At the end of 2014 the consumer prices index in China stood at 100.5. The inflation rate in the country in 2015 was 2%. Meanwhile, a number of countries in Europe experienced deflation. This had several consequences, including increasing the gap between the wages of skilled and unskilled workers. One major reason for the downward pressure on inflation was a fall in the global price of oil from US120 to US66 a barrel in 2015. This reduced the price of energy and transport. Lower transport costs had a noticeable impact on the price of food. Fig. 1 shows how the market for food was affected in 2015. At the same time as falling inflation, some countries experienced falling unemployment. Other countries, however, experienced both falling inflation and rising unemployment. For example, France saw unemployment rising between 2014 and 2015. This put upward pressure on French Government spending.

Mark scheme

Marking points from the official mark scheme (Oct/Nov 2017). The mark or mark type is shown in brackets.

1. [2] (a) Price stability / low inflation / stopping inflation rate rising above target (1) full employment / low unemployment (1).
2. [4] (b) 1 mark each for each of two problems identified: worsen current account position; redistribution of income; uncertainty; menu costs; shoe leather costs; inflationary noise; fiscal drag; higher unemployment; money may cease to carry out its functions; lower demand / lower output / lower economic growth; lower purchasing power / fall in the value of money; lower standards of living / higher cost of living. 1 mark each for each of two explanations: export prices will rise – reduce international competitiveness; lenders / those on fixed incomes may lose and borrowers may gain; lack of certainty may discourage investment; cost of changing e.g. price labels; cost of moving money around in search of highest interest rate; confusion caused by not being able to work out change in relative prices; people's income being dragged into higher tax brackets; costs of production may increase, causing firms to reduce the number of workers they employ; during periods of hyperinflation, money may cease to be generally acceptable; cost-push inflation will reduce total demand; purchasing power will fall if incomes rise by less than prices
3. [2] (c)(i) 45% (2) Correct working i.e. $54 / $120 × 100 (1)
4. [2] (c)(ii) 102.51 (2) Correct working i.e. 100.5 × 2 / 100 + 100.5 or 2.01 (1)
5. [5] (d) It may increase government spending on unemployment benefits (1) the unemployed may suffer worse health (1) this may increase government spending on healthcare (1) if crime rises, the government may spend more on law and order (1). To reduce unemployment, the government may adopt expansionary fiscal policy / policy to stimulate the economy / policy to increase economic growth (1) to increase total demand (1) to create more jobs (1). Government may provide subsidies to firms (1) to encourage them to increase output and employment (1). Government may spend more on education (1) to increase skills of workers (1) reduce structural unemployment (1). Unemployment may increase poverty (1) leading to more spending on other benefits (1). Government may employ more workers in the public sector (1) to reduce unemployment / will increase wage bill (1). Government may spend on infrastructure (1) to raise labour mobility (1).
6. [5] (e) Up to 3 marks for why it might: Levels of education and training may be low (1) in some developing countries there is a relatively high illiteracy rate (1) workers may lack skills/qualifications (1). Unskilled jobs may provide good non-wage benefits (1) example e.g. short working hours (1). The supply may be high due to immigration of unskilled workers / high population (1) attracted by wages that are higher than the countries they come from (1). Most workers may be employed in the primary sector (1) which may offer largely unskilled jobs (1). May be high unemployment (1) so some skilled workers may have to apply for unskilled jobs (1). May be high unemployment benefit (1) discourages incentive to work (1). Up to 3 marks for why it might not: Unskilled jobs are likely to be relatively poorly paid (1) wage rate is a key influence on jobs workers select (1). Unskilled jobs may offer poor working conditions (1) example e.g. hard manual work (1). Unskilled workers may emigrate to other countries (1) if wages/working conditions are better in other countries (1). Work may be capital-intensive (1) requiring high skills (1).
7. [4] (f) The diagram shows supply increasing (1) price falling (1) demand extending / more food / higher quantity (1) costs of production falling due to lower transport costs (1) inelastic supply (1) inelastic demand (1).
8. [6] (g) Up to 4 marks for why it might: A reduction in income tax will increase disposable income (1) may raise consumer expenditure (1) may raise investment (1) increase total demand (1) higher demand may encourage firms to raise prices / demand-pull inflation (1). Up to 4 marks for why it might not: Consumers may not spend more / may save more (1) if concerned about the future (1) if expect prices to be lower in the future (1). A decrease in income tax may not reduce deflation caused by lower costs of production (1) e.g. advances in technology / investment may continue pushing down the price level (1). A decrease in income tax may reduce government spending (1) higher consumer spending may be offset by lower government spending (1). May act as incentive to work (1) may increase productivity / efficiency (1) lower costs of production / increase total (aggregate) supply (1). Consumers may spend on imports (1).