1. Account for the fact that, even though food accounts for a relatively low proportion of consumer spending in the EU, rising food prices are adding to the measured rate of inflation.

Even though food is a relatively small part of the basket of goods, the increase in the food prices lead to an increase in inflation in the eurozone, from 2.1% to 2.6%. It is because the food prices are so big, the price of butter for instance raised by 40%. Moreover the rise in prices of food are pushing the inflationary expectations, which is also leading to an increase in inflation.

2. Using data from the stimulus material analyse the possible reasons for the increase in the food prices.

The extract 4 provides variety of possible reasons for the increase in the food prices. It firstly points that the UN are arguing that the increase was a result of increase in the price of oil, which is a necessary factor in production process of food. It is demonstrated in figure 4.1 that the price of oil raised from $50 per barrel in January 2007 to $85 in November. It also put forward the extreme weather that decreased the supply of food. The most important factor however was an increasing demand for the bio-fuels, and the fact that increasing amount of farmers would switch to production of this substitute of normal fuel. The farmers in the US – the greatest supplier of grain switched 20% of their land to bio-fuel production.

3. Why does the food inflation particularly affect the low-income people?

Because the money spend on food by them is a greater part of their income.

4. Comment on the consequences of the inflationary expectations

The increased inflationary expectations, ceteris paribus lead to an increase in the rate of inflation. Firstly, because the trade unions and ordinary workers will start to bargain higher wages to outweigh the loss resulting from an increase in inflation. Moreover, many may spend more, expecting fast deterioration of the purchasing power of their money. On the other, hand the increased inflationary expectations may lead to a greater uncertainty, and therefore increase in savings and shift of the aggregate demand curve to the left. This would case a reduced inflationary pressure. However, most likely to be outweigh by the other factors leading to an increase in inflation.

5. What is meant by the social consequence of inflation?

The social consequence of inflation is firstly the increased inflationary expectation, resulting in even higher inflation. If the inflation is cost-pushed and is leading to a significant increase in the cost of living. This would therefore lead to a situation in which the poorer part of the populace cannot afford basic foodstuff. This leads to an increasing frustration, and depending how severe is the inflation in some places where the administrative apparatus is weak and the rule of law weak may lead to riots, dangerous for the political order and therefore the state of the economy. The example of Russian politicians who try to diminish the effects of the inflation by imposing minimum price of food demonstrates the political response to an increase in the rate of inflation.

6. Analyse alternative explanations for food price rises other than those referred in the stimulus material.

Other possible causes of the food inflation are; the impact of trade liberalisation, distorted global rice market, and financial speculation. Financial speculation in commodity futures following the collapse of the financial derivatives markets has contributed to the crisis due to a "commodities super-cycle." It therefore means that the investors moved from financial derivatives to food, which increased the demand, hence the price of food.

One might argue that because the developing countries were depended on the imports of cheap, subsidised food from the developed countries, when the trade was liberalised, poorer countries had a big problem with producing enough food themselves.

Moreover, Restrictions were removed from Japan which contributes to lack of balance in the rice prices.

7. Why despite the opposition from agricultural interests, has reform of the Common Agricultural Policy been forced on the EU?

Because, the former way of functioning of the CAP lead to a disproportional increase in the supply. In the long run it meant that the money of taxpayers were allocated in stocks, and unused and crops. The oversupply of food was a typical example of market failure

8. With reference to intervention in agricultural markets, discuss the concept of government failure.

Government failure occurs when the government leads to misallocation of resources. It is when the resources, are allocated in impropriate way – if somebody could be better of without making others worse of.

The CAP was an example of a government failure. It lead to a situation in which a lot of resources were used to food production, while there was an oversupply of food.

Another example is the undersupply of food resulting from intervention of Kremlin into food market. It lead to an undersupply of food.

9. Why have economists warned that centralised controls are not appropriate ways of dealing with the food inflation?

Because, the government intervention tends to be inefficient. Moreover, it often results in unanticipated consequences, which lead to a misallocation of resources – example is the CAP.

10. Analyse the case for increasing the welfare benefits to enable people to cope with price rises.

The increase in welfare benefits has some pros. It is helping the group of people that are most severely hit by the inflation. Moreover, it does not interfere with the price mechanism.

On the other hand, it is not dealing with the causes of the problem, but only with the effects. In this term, it is ineffective.

11. Why would monetary policy in the form of interest rates rises only have a ‘very limited effect on food prices’? Identify and discuss the unintended consequences.

Monetary policies would have a very limited impact on the inflation, because of the fact that it is a cost-push inflation. Hence, the shift of the aggregate demand curve to the left, resulting from the increase in the interest rate, would have a very limited impact on the increase e in prices resulting from the shift of the aggregate supply curve to the left.

Additionally, the increase in the interest rates would lead to decrease in demand for durable goods, not needs of everyday need which is food.

The unintended consequences of an increase in the rate of interest, would be ceteris paribus increase in the exchange rate, therefore loss of competitiveness of given economy.

Other unintended consequence would be the loss in the pace of increase in the GDP.

12. To what extent do price controls tackle the problem of food inflation?

The food controls tackle to a vary limited extent the problem of social consequence of the increase in the food prices, by appeasing the poorest part of the society.

However, the decrease in the price of food, would result in the contraction on the supply curve, which would lead to a decrease in the quantity of produced food.

It would also lead to emergence of a black market economy.

13. Analyse the possible link between the food inflation and the monopoly.

Monopoly is an industry in which there is only one company. It can reduce output, which results in an increase in prices of produced product. This therefore leads to an increase in prices and allows the monopolist to enjoy the abnormal profits.

According to Vladimir Putin, the monopolists were abusing the food price inflation, and were restricting the output to gain more money. In this way the former president of Russia would justify imposition of minimum price of food.

If the monopolies were real, it would be possible that their existence contributed to the high prices of food.
14. Using a diagram to support your comments, explain why economist would be concerned about market becoming more monopolistic




The main problem with monopolies is that they tend to restrict output, to increase the price of the product. This action is profit-maximising, as demonstrated on the diagram, there profit maximising output (MR=MC) is where the price is relatively high. This leads to increase in the economic profit, as demonstrated on the diagram.

This is an obvious misallocation of the resources as the industry is not producing where the MC=AC

15. Analyse the consequences of interference in the price mechanism.

If the government interferes in the price mechanism this is most likely to a misallocation of resources, hence the government failure.

It is so because if the price is not settled by the demand and supply, there would be either over or undersupply of a good. Example is the interference of the of Kremlin, which by setting the maximum price for food, created a situation in which less food is produced than is actually demanded. This is demonstrated in the diagram below.


As demonstrated above, setting the maximum price – Max P leads to an under supply – Q2 minus Q1. It is because there is a contraction over the supply curve and expansion over the demand curve.

Setting a minimum price, most often for labour results in oversupply and in the example of labour, to unemployment. This is demonstrated on the diagram below.



Because of the contraction on the demand curve and the expansion over the supply curve there is an oversupply.