Paper 3 sample question
Inflation, price indices, exchange rates and policies to deal
with inflation
Markscheme
Zambia's inflation problem
Inflation is a problem in many African countries and Zambia is not an exception with an inflation rate
of 17.8%. This rate is currently being driven by price increases in food items with inflation running at
27% in this sector. One cause of Zambia’s inflation is the depreciation of its currency the kwacha
which has fallen significantly in the last 12 months.
Table 1 sets out price index data for the Zambian economy.
Price index data 2021
Category Price index Weighting
Food 167 26
Clothing 131 11
Transport 143 17
Housing 135
Energy 133 20
Other items 146 7
a. (i) Define the term inflation. [2]
Inflation is the continuous rise in the general level of prices in an economy.
Using the data in table 1:
(ii) Calculate the weighted index for food and clothing. [2]
(iii) Calculate the weighting for housing. [2]
(iii) Using Zambia’s 2021 inflation rate of 17.8%, calculate the weighted price index for 2020. [4]
© Alex Smith
InThinking [Link]/Economics 1
Price index data 2021
Category Price index Weighting Weighted index
Food 167 26 43.42
Clothing 131 11 14.41
Transport 143 17 24.31
Housing 135 19 25.65
Energy 133 20 26.60
Other items 146 7 10.22
Total 100 144.61
Weighted price index 2020: 144.61 /1.178 = 122.76
(iv) Using an aggregate demand and supply diagram, explain how a fall in the value of the Zambian
Kwacha might lead to a rise in inflation in Zambia. [4]
As the value of the Zambian Kwacha falls
it leads to a rise in import prices. A rise in
import prices will increase the costs of
businesses that import raw materials,
components and finished goods into
Zambia. This increase in costs will shift
the short-run aggregate supply curve
from SRAS to SRAS1 which will cause the
average price level to increase from P to
P1 in Zambia and lead to a rise in its
inflation rate.
The exchange rate in 2021 between the US$ and the Zambian Kwacha is $1 = ZK3500 this has fallen
from $1 = KW2750 in 2020. Zambia exports copper to the US at a price of ZK32,000,000 per tonne.
(v) Calculate the $US price of Zambian copper exported to the US at $1 = ZK3500 and $1 =
KW2750. [2]
2020: 32,000,000 / 2750 = $11,636.36
2020: 32,000,000 / 3500 = $9,142.85
© Alex Smith
InThinking [Link]/Economics 2
(vi) Explain the effect the change in the value of the US Dollar against the Zambian Kwacha might
have on Zambia’s exported copper revenues if the demand for Zambian copper is price elastic. [4]
As the value of the Zambian Kwacha has depreciated against the US dollar the price of Zambian
copper in the US has fallen. Because the demand for Zambian copper is price elastic in the US there
will be a rise in Zambian copper revenue because total revenue rises when the price falls if the
demand for a good is price elastic.
b. Using the data provided and your knowledge of economics, recommend a policy the Zambian
government might choose to reduce inflation. [10]
Answers should include:
• Definition of inflation.
• Explanation that contractionary
monetary policy could be used to
reduce inflation where the
Zambian government increases
interest rates to reduce aggregate
demand and decrease the
average price level. This is shown
in the diagram where AD shifts to
AD1 and the average price level
falls from P to P1.
• Explanation that contractionary fiscal policy could be used by the Zambian government to
reduce inflation. This means increasing taxation and decreasing government expenditure to
reduce aggregate demand and the average price level. This is shown in the diagram where
AD shifts to AD1 and the average price level falls from P to P1.
• Explanation that the Zambian
government could use
interventionist supply-side
policies to reduce inflation. This
might include subsidising and /or
putting a maximum price on
certain key goods such as energy
and basic food. These policies
aim to increase supply-side
efficiency and reduce the average
price level as LRAS increase to
LRAS1 in the diagram.
© Alex Smith
InThinking [Link]/Economics 3
• Explanation that the Zambian government could use market-based supply-side policies to
reduce inflation. This might include deregulation, reducing the power of trade unions,
privatisation, reduced taxation, and a strong competition policy. These policies aim to
increase supply-side efficiency and reduce the average price level as LRAS increase to LRAS1
in the diagram.
Evaluation/synthesis might include the discussion of the difficulties of using contractionary monetary
policy and fiscal policy. Both policies lead to a fall in AD which can lead to a decrease in economic
growth or even a recession and these policies are more difficult to apply with cost-push inflation.
There could also be a discussion of the problems using interventionist and market-based supply-side
policies such as the costs of using subsidies, the difficulties of imposing price controls, the
exploitation of workers if trade union power is reduced and the negative consequences for the
environment if regulations are removed. A discussion might also include the long-term nature of
market-based supply-side policies and their weakness in dealing with a current inflation problem.
The answer should include a final policy suggestion.
© Alex Smith
InThinking [Link]/Economics 4
