Inflation | Model Answer
A-level Economics
“Explain two reasons why the existence of spare capacity in an economy is likely to help keep inflation low..”
Here is a question and answer from the markets and national economy section of the A-level Economics syllabus.
This question is an ‘explain’ question - the type of question where students have to showcase their knowledge. This question shows the examiner that ‘you know your stuff’.
You have to ensure you try very hard with these questions because answering without enough detail can lead to precious lost marks.
Explain two reasons why the existence of spare capacity in an economy is likely to help keep inflation low.
The question asks you to give 2 reasons why spare capacity can help keep inflation low. You will need to structure this properly, never forgetting to stick to the question be asked. Remember to put some definitions in there and remember to insert your diagram!
ESSAY PLAN
Possible Definitions
Inflation
Inflation can be defined in a number of ways. Firstly, inflation can be defined as a reduction in the purchasing power of money. Secondly, inflation can be defined as a sustained increase in the general price level.
Spare Capacity
pare capacity in the economy refers to a state of productive inefficiency, where the maximum level of resources are not being employed. One way to illustrate this would be to use a PPF curve. (draw PPF or similar diagram)
Reason 1: Lower aggregate demand compared with aggregate supply
Spare capacity - means aggregate demand is relatively low (or supply is relatively high)
More competitive business environment
Draw AD/AS diagram showing short run period and the economy’s resistance to demand-pull inflation
Reason 2: Low wages
Explain why wages are likely to be kept low during this period
Why would the economy be in recession
The relationship between wages and prices
Why would firms be looking to cut wages or workers?
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