A Level Economics: Problems in China's Economy

 

China’s recent economic woes suggest there is something seriously amiss

George Magnus in The Guardian

At a Politburo meeting last month, China’s leaders referred to the economic recovery this year as “torturous”. You won’t often hear such candour coming from a Chinese Communist party institution, let alone such an elevated body. They were referring to current conditions, of course, but China’s problems reveal much that is systemically out of kilter in its economic and political system.

During the past few days, some of the statistics China has published have caused a stir. Consumer prices in July were lower than a year ago, suggesting it might be on the cusp of deflation, which reflects a chronic shortage of demand in the economy. And China’s foreign trade in the same month showed a sharp fall in exports due to weak global demand, with a sharper decline in imports signifying weakness in demand at home. There were murky factors affecting both but the message is that something more serious is amiss in China.


Indeed, China was widely expected to bounce back from the pandemic and there was a bit of a flurry early in 2023. Yet, consumption has generally been very subdued especially for big-ticket items such as cars and houses, and private investment, the backbone of China’s economy, fell in the first half of this year, for the first time since such data was published many years ago.

Private firms and entrepreneurs are not spending much on investment or on hiring people. Youth unemployment has topped 21%, or double what it is in the UK and almost three times the rate in the US. The annual graduation of 11-12 million students in the the summer is aggravating an already difficult situation because of the problems of finding suitable work, and also because the Chinese labour market has become one in which most jobs are in the lower-pay, low-skill, gig or informal economy compared with higher quality jobs in manufacturing and construction.

It would be wrong though to pin this all on the pandemic. Most things weighing on China’s economy have been building for several years, even while much of the world was wowed by China’s global brands such as Huawei, Alibaba, Tencent and TikTok, property was booming, and China was leaving its footprint all over the world through the “belt and road” initiative and its rising governance engagement with global entities such as the International Monetary Fund and the World Health Organization.

In spite of its unequivocal accomplishments and successes, China has, during the past decade or more, spawned a mountain of bad debt, unprofitable and uncommercial infrastructure and real estate, empty apartment blocks and little-used apartments and transport facilities, and excess capacity in, for example, coal, steel, solar panels and electric vehicles. Productivity growth has stalled, and China can unfortunately boast one of the world’s highest levels of inequality.

It is ageing faster than any other country on the planet but with a skinny social security system in which most of its 290 million migrant workers are not eligible for most social benefits. Under Xi Jinping, moreover, it has also developed an increasingly repressive, state-centric and controlling governance system, both for political reasons and to deal with the effects of its failing development model.

These are testing times for Chinese citizens, especially the fabled rising middle class whose savings have mostly found a home in an outsized real estate sector which has now entered a period of structural decline. Most of the housing stock, overbuilding, collapse in transactions and weakness in prices are not in big agglomerations such as Beijing, Shenzhen and Shanghai, but in hundreds of smaller cities and towns that rarely make news.

China’s leaders have been vocal this year about strengthening consumption and about improving the business environment for private firms and entrepreneurs, who have been pressured or punished to align their commercial interest with the party’s political goals. We still await evidence that such rhetoric has substance.

In the coming weeks and months, we should probably expect the authorities to ease financial and budgetary policies, housing regulations, and borrowing caps to finance infrastructure. There might even be measures that look consumer-friendly but also fail to boost the income that alone can sustain higher consumption.

These things may give the economy a temporary lift over the winter but the underlying weakness of the economy and the greater authoritarianism that China features are now two sides of the same coin that seem irreversible, certainly for the time being.

It is a moot point whether this sort of China in the 2020s is a bigger threat to geopolitical stability than one in which it confidently strides the world stage and is able to brush aside liberal leaning democracies and reframe global governance in its interests. But a crucial one to get right.

A Level Economics: Practice Questions on Inflation

 

1. The CPI for the base year is 100. If the CPI for the current year is 120, what is the inflation rate? A) 20% B) 12% C) 2% D) 0.2%

Answer: A

2. The GDP deflator for a country in 2022 is 125. If the nominal GDP in 2022 was $800 billion, what was the real GDP for the same year? A) $640 billion B) $1,000 billion C) $575 billion D) $640,000 billion

Answer: A

3. The price of a basket of goods in 2021 was $200. If the price of the same basket increased to $220 in 2022, what was the inflation rate using the Laspeyres index formula? A) 10% B) 8% C) 9% D) 11%

Answer: C

4. The inflation rate for a country in Year 1 was 4%. In Year 2, the inflation rate was -2%. What was the average annual inflation rate over the two years? A) 2% B) 1% C) 3% D) 0%

Answer: C

5. In 2021, the average price of a product was $50, and the same product's price increased to $60 in 2022. If a consumer earned $75,000 in 2021 and $85,000 in 2022, what was the consumer's real income change between the two years? A) $10,000 increase B) $5,000 decrease C) $7,000 increase D) $10,000 decrease

Answer: C

6. The Consumer Price Index (CPI) for a basket of goods is as follows:

• Base year CPI (2015): 150
• CPI in 2020: 180 What is the percentage increase in the price level from the base year to 2020 using the Paasche index? A) 20% B) 18% C) 16.67% D) 12%

Answer: B

7. A country's inflation rate was 5% last year. This year, the country experienced a demand-pull inflation, and the inflation rate increased to 8%. What was the percentage increase in aggregate demand leading to the inflation surge? A) 3% B) 8% C) 60% D) 5%

Answer: A

8. The producer price index (PPI) for a set of goods in the base year was 120. In the current year, the PPI for the same goods increased to 150. What is the percentage increase in the producer prices? A) 20% B) 25% C) 30% D) 50%

Answer: B

9. If the inflation rate is 3% and your nominal wage increased from $3,000 to $3,300, what is your real wage change? A) $180 decrease B) $150 increase C) $300 increase D) $90 decrease

Answer: B

10. In 2022, the average price of a laptop was $800, and in 2023, it increased to $850. At an inflation rate of 4%, what was the real price change of the laptop from 2022 to 2023? A) $34 B) $40 C) $30 D) $20

Answer: C

1. What is inflation? A) A decrease in the general price level B) The rate at which the economy grows C) An increase in the general price level D) The rate at which the currency depreciates

Answer: C

2. Disinflation is best described as: A) A decrease in the inflation rate B) A period of deflation C) A decrease in the money supply D) A rapid increase in the inflation rate

Answer: A

3. Deflation occurs when: A) Prices are stable, neither increasing nor decreasing B) The inflation rate is negative, indicating a decrease in the price level C) The inflation rate is zero, indicating no change in the price level D) The inflation rate is positive, indicating an increase in the price level

Answer: B

4. The Consumer Price Index (CPI) measures: A) The average price of goods and services consumed by businesses B) The cost of living for a specific group of individuals C) The economic growth rate of a country D) The average price of goods and services consumed by households

Answer: D

5. Inflation is calculated as: A) ((Current year CPI - Previous year CPI) / Current year CPI) x 100 B) ((Current year CPI - Previous year CPI) / Previous year CPI) x 100 C) ((Previous year CPI - Current year CPI) / Current year CPI) x 100 D) ((Previous year CPI - Current year CPI) / Previous year CPI) x 100

Answer: A

6. If the CPI in 2022 was 180 and the CPI in 2021 was 160, what was the inflation rate between 2021 and 2022? A) 10% B) 12.5% C) 11.11% D) 20%

Answer: C

7. The term "core inflation" refers to: A) Inflation that affects only specific industries B) Inflation excluding certain volatile food and energy prices C) Inflation caused by changes in the interest rates D) Inflation calculated using the Producer Price Index (PPI)

Answer: B

8. Demand-pull inflation occurs when: A) Aggregate demand exceeds aggregate supply, leading to rising prices B) Aggregate supply exceeds aggregate demand, leading to falling prices C) The government increases taxes, leading to higher consumer prices D) Consumer spending decreases, causing a decrease in prices

Answer: A

9. Cost-push inflation is caused by: A) A decrease in production costs, leading to lower prices B) An increase in aggregate demand, leading to higher prices C) A decrease in wages and salaries, leading to lower prices D) An increase in production costs, leading to higher prices

Answer: D

10. Which of the following is a possible effect of inflation on savers and investors? A) Decreased purchasing power of savings and investments B) Increased value of savings and investments C) No impact on savings and investments D) Higher interest rates on savings accounts

Answer: A

11. Hyperinflation is characterized by: A) An extremely high inflation rate, usually exceeding 50% per month B) A steady and moderate increase in prices over time C) A decrease in the money supply D) A deflationary spiral

Answer: A

12. The inflation rate can be negative during: A) Disinflation B) Cost-push inflation C) Deflation D) Demand-pull inflation

Answer: C

13. If a basket of goods and services has a base year cost of $1,000 and the current-year cost is $1,200, what is the inflation rate using the Paasche index formula? A) 18% B) 20% C) 16.67% D) 12%

Answer: B

14. The GDP deflator is a price index that measures the average price change of all goods and services in: A) A specific region or country B) The consumer market only C) The producer market only D) The international market

Answer: A

15. Cost-push inflation is often caused by: A) Decreased taxes B) Rapid economic growth C) Increase in wages D) Reduced government spending

Answer: C

16. Which of the following is an example of "creeping" inflation? A) An inflation rate of 2% per year B) An inflation rate of 8% per year C) An inflation rate of 15% per year D) An inflation rate of 0% per year

Answer: A

17. Which organization in the United States is responsible for calculating and publishing the Consumer Price Index (CPI)? A) Federal Reserve (the Fed) B) Internal Revenue Service (IRS) C) Bureau of Labor Statistics (BLS) D) Department of Commerce

Answer: C

18. If the inflation rate exceeds the nominal interest rate, what happens to the real interest rate? A) The real interest rate becomes negative B) The real interest rate remains unchanged C) The real interest rate increases D) The real interest rate decreases

Answer: A

19. What is the key difference between deflation and disinflation? A) Deflation refers to a decrease in the inflation rate, while disinflation refers to a decrease in the price level. B) Deflation refers to a decrease in the price level, while disinflation refers to a decrease in the inflation rate. C) Deflation refers to a decrease in aggregate demand, while disinflation refers to a decrease in aggregate supply. D) Deflation refers to a decrease in the money supply, while disinflation refers to an increase in the money supply.

Answer: B

20. The inflation rate is calculated using which of the following price indexes? A) GDP Deflator B) Producer Price Index (PPI) C) Consumer Price Index (CPI) D) Both A and C

Answer: D

1. The consumer price index (CPI) for a basket of goods increased from 150 to 165 over one year. What was the inflation rate using the Laspeyres index formula, assuming the base year is the earlier year? A) 10% B) 8.33% C) 11.11% D) 15%

Solution: CPI Increase = (165 - 150) / 150 = 0.10 or 10% Inflation Rate (Laspeyres) = CPI Increase × 100 = 10% × 100 = 11.11%

Answer: C

2. The GDP deflator for a country in 2023 is 120. If the nominal GDP in 2023 was $2.4 trillion, what was the real GDP for the same year, measured in billions? A) $2,000 B) $2,100 C) $2,200 D) $2,300

Solution: Real GDP = (Nominal GDP / GDP Deflator) × 1000 Real GDP = ($2.4 trillion / 120) × 1000 = $2,000 billion

Answer: A

3. A country experienced 3 consecutive years of inflation with rates of 5%, 8%, and 12%. What was the average annual inflation rate over the three years? A) 8.33% B) 7.67% C) 8% D) 10%

Solution: Average Inflation Rate = (5% + 8% + 12%) / 3 = 25% / 3 ≈ 8.33%

Answer: A

4. The Paasche price index for a basket of goods is as follows:

• Base year quantity: 100 units, Base year price: $10 per unit
• Current year quantity: 120 units, Current year price: $15 per unit What is the percentage increase in the price level from the base year to the current year using the Paasche index? A) 50% B) 67% C) 100% D) 80%

Solution: Paasche Price Index = (Current Year Expenditure / Base Year Expenditure) × 100 Current Year Expenditure = 120 units × $15 per unit = $1800 Base Year Expenditure = 100 units × $10 per unit = $1000 Paasche Price Index = ($1800 / $1000) × 100 = 180% Percentage Increase in Price Level = Paasche Price Index - 100 = 180% - 100% = 80%

Answer: D

5. In 2022, the average price of a car was $25,000, and in 2023, it increased to $28,000. If the inflation rate for the period was 5%, what was the real price change of the car from 2022 to 2023? A) $3,000 B) $2,500 C) $2,000 D) $1,750

Solution: Real Price Change = Nominal Price Change - Inflation Rate Nominal Price Change = $28,000 - $25,000 = $3,000 Real Price Change = $3,000 - (5% × $25,000) = $3,000 - $1,250 = $1,750

Answer: D

6. A country's CPI in 2021 was 200, and in 2022, it increased to 220. Calculate the inflation rate using the Paasche index formula, assuming 2021 as the base year. A) 12% B) 8% C) 10% D) 9.09%

Solution: CPI Increase = (220 - 200) / 200 = 0.10 or 10% Inflation Rate (Paasche) = CPI Increase × 100 = 10% × 100 = 10%

Answer: C

7. The GDP deflator for a country in 2020 was 110, and in 2021, it was 105. Calculate the disinflation rate for the period. A) 4.55% B) 4.76% C) 4.17% D) 5%

Solution: Disinflation Rate = (GDP Deflator in Earlier Year - GDP Deflator in Later Year) / GDP Deflator in Earlier Year × 100 Disinflation Rate = (110 - 105) / 110 × 100 ≈ 4.55%

Answer: A

8. The Producer Price Index (PPI) for a set of goods in the base year was 140. In the current year, the PPI for the same goods decreased to 120. What is the percentage change in the producer prices? A) -14.29% B) -16.67% C) 14.29% D) 16.67%

Solution: Percentage Change = [(Current PPI - Base PPI) / Base PPI] × 100 Percentage Change = [(120 - 140) / 140] × 100 ≈ -14.29%

Answer: A

9. In 2022, the average salary for a profession was $60,000, and in 2023, it increased to $68,000. The CPI for 2022 was 180, and for 2023, it was 190. Calculate the real wage change between 2022 and 2023. A) $4,000 increase B) $6,000 increase C) $2,456 increase D) $8,000 increase

Solution: Real Wage Change = (Nominal Wage / CPI) * 100 (From 2022 to 2023) Real Wage Change = ($68,000 / 190) * 100 - ($60,000 / 180) * 100 Real Wage Change = $35,789 - $33,333 ≈ $2,456

Answer: C

10. A country experienced an inflation rate of 6% last year and 12% this year. If the inflation rate follows a geometric progression, what will be the inflation rate for next year? A) 10% B) 12% C) 15% D) 9%

Solution: Geometric Mean = √(Inflation Rate of Last Year × Inflation Rate of This Year) Geometric Mean = √(6% × 12%) = √(0.06 × 0.12) ≈ 0.09 or 9%

Answer: D

--- Essay Questions

Explain why moderate inflation is preferred over deflation. Discuss the potential risks of deflation and how a low, positive rate of inflation helps mitigate these risks. Provide real-world examples of countries that have faced deflationary pressures and analyze their strategies to combat such challenges.

Analyze the role of central banks in managing inflation and interest rates during deflationary situations. Discuss the challenges faced by central banks when inflation is too low or negative, reaching the "zero lower bound." Evaluate the effectiveness of monetary policy tools, such as quantitative easing and negative interest rates, in stimulating the economy during periods of low inflation or deflation. Provide case studies of countries that have implemented unconventional monetary policies to address deflationary pressures.

Discuss the effectiveness of monetary policies in stimulating the economy during periods of low inflation or deflation. Evaluate the role of fiscal policy and structural reforms in addressing deflationary risks. Analyze the winners and losers of low inflation, considering the impacts on savers, lenders, borrowers, and fixed-income earners. Compare and contrast the consequences of low inflation and deflation on consumer behavior, business investments, and overall economic growth.

Discuss the redistributive effects of inflation and its impact on different socioeconomic groups in the economy. Analyze how inflation can lead to wealth and income redistribution, affecting fixed-income individuals, borrowers, and lenders. Evaluate the implications of these redistributive effects on social and economic inequalities. Provide real-world examples to illustrate the consequences of inflation on different segments of the population.

Analyze the macroeconomic effects of high and unpredictable inflation on an economy. Evaluate how inflation can impact various macroeconomic objectives, such as price stability, economic growth, employment, external balance, and financial stability. Discuss the challenges policymakers face in managing inflation to achieve these objectives effectively. Assess the role of inflation targeting as a monetary policy framework in balancing the costs and benefits of inflation. Provide case studies of countries that have experienced macroeconomic instability due to inflation and their policy responses to address inflationary pressures.

Explain the role of expectations in sustaining and driving inflation, with a focus on the wage-price spiral. Discuss how expectations of future inflation influence wage negotiations and price setting, leading to a self-reinforcing cycle of rising wages and prices. Analyze the factors that contribute to the formation of inflationary expectations and their impact on the overall inflationary environment. Evaluate the challenges policymakers face in managing inflation when expectations become unanchored. Provide real-world examples to illustrate the significance of expectations in inflation dynamics.