Question

QUESTION FOUR [30]

4.1 “With increasing global surface temperatures, the possibility of more droughts and increased intensity of storms is like to occur in many countries.” In terms of the above statement, discuss the type of inflation that is likely to increase. Motivate your answer with the aid of a diagram.

Answer 1

The given statement states that the increasing global temperature may likely arise the situation of more droughts and intensity of the storm in various nations. Droughts may lead to damage to the crops of the farmers due to which there will be lesser output produced that decreases the supply of products in the market. Such a situation may lead to an increase in the price level, and that, in turn, increases inflation.

This type of inflation is known as the cost-push inflation that is a supply-side cause. Inflation arises due to drought and storms because farmers lose their crops, which will increase the cost of producing crops. As a result, the farmer will raise the price of the products to compensate for their losses. Therefore, real GDP decreases and the price level increase in the economy, as shown in the graph below: