Table 1 shows economic data collected by the finance ministry over three years. Inflation has become a concern because a rise in the general price level can...
Question 1 Report
Table 1 shows economic data collected by the finance ministry over three years. Inflation has become a concern because a rise in the general price level can reduce the real value of household cash. The ministry is considering increasing interest rates. Roja's Furniture, a family business, has a bank loan for new machinery and sells sofas on credit. Its owner wants to know how this policy could affect sales, costs and profit.
(a) Define inflation. [2]
(b) Calculate the percentage increase in the inflation rate from 2023 to 2025. [3]
(c) State one likely effect of higher interest rates on Roja's Furniture and one likely effect on its customers. [3]
(d) Analyse whether increasing interest rates is likely to achieve the government's objective of lower inflation. [4]
Answer Details
(a) Inflation is a sustained, general increase in the prices of goods and services. It concerns the overall price level, not just a price rise for one product. [2]
(b) The inflation rate rises from 3.0% to 5.4%, an increase of 2.4 percentage points. Percentage increase is calculated from the original rate:
\[\frac{5.4-3.0}{3.0}\times100=80\%\]
The percentage increase is 80%. [3]
(c) Higher interest rates increase Roja's Furniture's loan repayments or interest costs. For customers, buying sofas on credit becomes more expensive, so some may delay purchasing. This can reduce the firm's demand and sales. [3]
(d) Higher interest rates make borrowing and credit spending less attractive. Consumers may save more and spend less, reducing total demand in the economy. With weaker demand, businesses find it harder to keep increasing prices. This reduces inflationary pressure, so the policy is likely to help achieve lower inflation. [4]
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