Economics: Inflation, Restrictive Trade, and Fiscal Policies

Economics 1
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Economics 2
Q1
Inflation is the persistent rise in general levels of prices leading to a decline in purchasing
power. The level of inflation in a country is measured using the retail price index (RPI) which
measures change in average price of a unit of goods and services that represent the consumption
pattern of a typical household RPI valid (Ball, 2017). Demand-pull inflation occurs when
aggregate demand in the economy is more than the aggregate supply. The increasing costs of
production pushes price levels higher. Demand-pull inflation occurs when value of aggregate
demand exceeds that of output at full employment.
Figure 1
From the graph above, aggregate demand rises from AD1 to AD2 leading to a price
increase from P1 to P2. The impact of this type inflation is that, too much money will be chasing

Economics 3
few products (Bos, 2014). The increased demand motivates producers to produce more products
leading to full employment in the short run and higher economic growth in the long run.
Cost push inflation develops when cost of production in an economy. The increase in cost
of production is majorly as result of increased cost of raw materials, and labor costs. The rise in
fuel prices in the manufacturing industry is a common cause of cost push inflation (Ehrenberg &
Smith, 2016) .From the graph below, businesses increased product prices from P1 to P2 so as to
maintain their profits as they were before the risk in the cost of production. The GDP declined
from Y1 to Y2 leading to an increase in economic unemployment in the short run and a decline
in economic growth in the long run.
Monetary policies are decisions and actions taken by the state through the central bank
that ensure consistency of money supply and government growth and pricing objectives. The aim
of monetary policies is to maintain stability in prices in the country. There exist several monetary
policy measures that the government can implement. Minimum reserve requirements are the
least amount of cash that commercial banks are allowed to operate with (Dar & Amirkhalkhali,
2017).The government can also float government bonds to individuals and corporates through
open market operations. The central bank can also engage in Forex transactions to withdraw
from or inject liquidity from to the market.
Fiscal policies are inflation control measures where the government adjusts its taxes and
expenditure in order to stabilize the currency. Fiscal policies are combined with monetary
policies and used to control the country’s economy. Reducing government expenditure lowers
the level of inflation by reducing the amount of money in circulation in the economy. Fiscal
policies are based on managing demand by ether reducing or raising aggregate demand (Korinek,
2018). This policy is effective only in controlling demand pull inflation.