9708 · 4.6

Price stability — practice questions

Practice and worked examples for 9708 Price stability. Short previews only — attempt the full question in MarkScheme against the official scheme.

Worked example 1

The CPI was 110 in 2023 and 116.6 in 2024.

(a) Calculate the inflation rate. (b) A worker's nominal wage rose from $30,000 to$ 31,500. Calculate the real wage change. (c) Identify whether this is demand-pull or cost-push if AD also rose sharply while oil prices were stable.

Show solution outline

(a) Inflation rate = ((116.6 − 110) ÷ 110) × 100 = 6.0%

(b) Real wage change Nominal wage increase = ((31,500 − 30,000) ÷ 30,000) × 100 = 5.0% Real wage change ≈ 5.0% − 6.0% = −1.0% (real wage fell — purchasing power declined)

(c) Type of inflation With AD rising sharply and no oil shock → demand-pull inflation. AD shifted right beyond productive capacity, pushing P up.

Worked example 2

An oil price shock increases production costs. On a separate AD–AS diagram:

(a) Show the effect on P and Y. (b) Explain why contractionary monetary policy may be inappropriate. (c) Suggest one supply-side response.

Show solution outline

(a) Diagram SRAS shifts left from SRAS₁ to SRAS₂. New equilibrium: higher P, lower Y — stagflation.

(b) Inappropriate contractionary policy Raising interest rates reduces AD further, deepening the recession (Y falls more) while only partially offsetting cost-push inflation. The problem is supply-side, not excess demand.

(c) Supply-side response Subsidise energy transition, invest in alternative inputs, or negotiate productivity deals — aim to shift SRAS back right rather than suppress AD.

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