Inflation questions look friendly. Everyone knows prices go up. That is exactly why they are where good H2 Economics scripts quietly lose marks. If you are in JC1 or JC2 in Singapore, or revising before a place at NUS, NTU or SMU, the six slips below are the ones that turn a solid essay into an average one, and the first things good economics tuition fixes. Each comes with the correction and, where it helps, the diagram that proves it.
Slip 1: calling every price rise inflation
A single price going up is not inflation. Nor is a one-off jump in many prices, such as the step up when a consumption tax rises by a percentage point. Inflation is a sustained rise in the general price level, measured by an index such as the consumer price index (CPI). If you are hazy on how that index is built, review how inflation and GDP are measured before going further.
Two words in that definition do the work. “General” rules out relative price changes: durians getting dearer while electronics get cheaper is a change in relative prices, not necessarily inflation. “Sustained” rules out one-off level shifts: a tax increase lifts the CPI once, and the measured inflation rate falls back a year later unless something keeps prices climbing. Strong answers make this distinction early, because every later claim depends on it.
Slip 2: assuming more demand always means more inflation
Demand-pull inflation is caused by aggregate demand (AD) growing faster than the economy’s ability to produce. The slip is to say that any rise in AD causes it. Whether it does depends on how much spare capacity there is. That is what the shape of the Keynesian aggregate supply (AS) curve is for. It is flat when many resources are idle, steepens as firms run into bottlenecks, and turns vertical at full employment. If AD–AS itself needs revisiting, start with the AD–AS framework.
Read Figure 1 from left to right. The four AD curves are equally spaced, so every shift is the same size. The first raises real GDP by about 24 while the price level rises by only about 4. The second adds about 19 to output and 11 to the price level. The third adds only about 10 to output but about 25 to the price level. Across the three shifts the price level climbs from 102.5 to 142.8, and most of that comes at the end. Same push, very different result.
One shift gives a one-off jump in the price level. Inflation, a sustained rise, needs AD to keep growing faster than capacity, year after year. So the precise statement is this: persistent increases in AD cause demand-pull inflation when the economy is near full capacity. With large spare capacity it mainly raises output and employment. In an essay, always say where the economy is on the AS curve before you predict inflation.
Slip 3: drawing cost-push as if it were demand-pull
Cost-push inflation starts on the supply side. Wages, raw materials, imported components or rents rise, so firms need higher prices to supply the same output. On the diagram, AS shifts up. AD does not move.
The slip is to shift AD instead, or to shift AS but then claim that output rises. Look at what the shift actually does.
With AD unchanged, the equilibrium moves from E₁ to E₂. The price level rises from about 111 to 122, while real GDP falls from about 73 to 65. Rising prices together with falling output and employment is called stagflation, and it is the signature of cost-push. If your diagram shows prices and output rising together, you have drawn demand-pull, whatever your paragraph says. And as with Slip 2, one shift is a one-off rise in the price level. Cost-push becomes sustained inflation only if costs keep rising, for example through repeated wage rounds, or if policy accommodates each shock by adding demand.
Slip 4: treating MV = PY as proof that money causes inflation
The quantity equation says M × V = P × Y: the money supply times its velocity (how many times each dollar is spent on final goods and services in a year) equals the price level times real output. Students often present it as a theory. It is not, on its own. It is an identity, true by definition, because both sides measure total spending.
It becomes the quantity theory of money only when you add two assumptions: velocity is constant, or at least unaffected by the money supply, and real output is fixed at full capacity in the long run. Then P must move in proportion to M. In growth-rate form, a useful approximation is:
- money growth + velocity growth ≈ inflation + real output growth.
Suppose the money supply grows 8% a year, velocity is constant and real GDP grows 3%. Inflation is approximately 8 + 0 − 3 = 5%. The exact figure is 1.08 ÷ 1.03 − 1, about 4.85%, close enough that the approximation is fine in an exam.
The evaluation marks come from questioning the assumptions. Velocity is not constant. It shifts with interest rates, payment technology and confidence, and it can fall sharply in a recession. And when there is spare capacity, more money can raise Y rather than P, which is Slip 2 again. A strong answer uses the quantity theory as a long-run benchmark and says why the short run differs.
Slip 5: forgetting the inflation that arrives through imports
In a small economy that imports much of what it consumes and uses in production, a large share of inflation is imported. When the world prices of food, fuel or components rise, they raise the CPI directly through imported consumer goods, and indirectly by raising firms’ costs, which is cost-push.
A worked number shows the scale. Suppose imports make up 40% of the consumer basket and their foreign-currency prices rise 10%, with domestic prices unchanged. The CPI rises by about 0.4 × 10% = 4%. Now suppose the domestic currency appreciates, so that foreign currency costs 5% less. The local price of imports rises only 1.10 × 0.95 − 1 = 4.5%, and the CPI by about 0.4 × 4.5% = 1.8%.
That calculation is why a central bank in a very open economy may steer the exchange rate rather than an interest rate. A stronger currency lowers the local price of imports, though firms rarely pass the whole saving on, and it also cools demand by making exports dearer. With capital free to move, domestic interest rates in such an economy largely follow world rates anyway. Pointing out that the right inflation tool depends on how open the economy is earns evaluation marks.
Slip 6: prescribing one cure for every inflation
The remedy must match the cause. For demand-pull, contractionary fiscal or monetary policy that reduces AD is the textbook answer. Central banks that set an interest rate usually aim it at an explicit target, as the lesson on inflation targeting and central bank independence explains.
For cost-push, the same medicine is far more painful. Go back to Figure 2. After the cost shock, suppose the government squeezes AD (the dashed line). The economy moves from E₂ to E₃. The price level falls by less than 3, from about 122.4 to 119.6, still well above the original 110.7, while real GDP drops further, from about 65 to 54. Here, with spare capacity already opened up by the shock, the economy sits on a fairly flat stretch of AS, so the squeeze buys very little price stability for a lot of lost output. The case for tightening anyway is about expectations. If workers and firms come to expect higher inflation, the one-off shock can turn into a wage-price spiral, and a central bank may tighten to stop those second-round effects. Better answers pair a short-run response with supply-side measures that lower costs or raise productivity, such as training, infrastructure or improving competition, and note that these take time.
Three questions to try
Question 1. The money supply rises from 400 billion to 440 billion. Velocity is 2.5 and real output is 1,000 billion, both unchanged. Find the price level before and after, and the inflation rate.
Answer. From P = M × V ÷ Y, the price level is 400 × 2.5 ÷ 1,000 = 1.0 before and 440 × 2.5 ÷ 1,000 = 1.1 after. Inflation is 10%, the same as the money growth, because V and Y are fixed.
Question 2. Money grows 6% a year, velocity falls 1% and real GDP grows 2%. Estimate inflation, then give the exact figure.
Answer. Approximately 6 − 1 − 2 = 3%. Exactly, 1.06 × 0.99 ÷ 1.02 − 1 is about 2.9%.
Question 3. Imported goods are 30% of the consumer basket and their foreign-currency prices rise 20%, with domestic prices unchanged. By how much does the CPI rise? If the domestic currency appreciates so that foreign currency costs 10% less, what happens to the local price of imports and to the CPI? Name the type of inflation.
Answer. The CPI rises about 0.3 × 20% = 6%. With the appreciation, imports rise only 1.2 × 0.9 − 1 = 8% in local currency, and the CPI about 0.3 × 8% = 2.4%. This is imported inflation, which works as cost-push where the imports are inputs to production.
Common follow-up questions
Is a wage-price spiral demand-pull or cost-push? It usually starts as one and becomes both. Higher prices lead workers to demand higher wages, which raise costs (cost-push). The higher wages also raise spending (demand-pull), and expectations of further inflation keep the cycle going.
Is falling inflation the same as falling prices? No. Disinflation means prices are still rising, but more slowly. Deflation means a sustained fall in the general price level. Mixing the two up in a data-response answer is an easy way to lose a mark.
Should I always draw the Keynesian AS curve? Use it when spare capacity matters to your argument, as it does for demand-pull. If your notes use an upward-sloping short-run AS curve instead, the cost-push logic is identical: the curve shifts up, and output falls.
Essay practice with an economics tutor in Singapore
H2 inflation questions reward the same moves again and again: define precisely, identify the cause, draw the matching diagram and evaluate the policy for the economy in front of you. In Singapore that last step means explaining why the exchange rate, not an interest rate, is the inflation tool in one of the world’s most open economies, and it is the part students find hardest to write under time pressure. A tutor can mark your own essays and case-study answers against those moves, one script at a time. See how to start.
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