Cambridge International as and a level Economics Ebook

SELF-ASSESSMENT TASK 
5.6
In 2013 the Mexican government introduced a 
number of new taxes. Th
ese included a value-added 
tax of 16% on public transport and a tax of 8% on 
food containing a high number of calories. It also 
imposed a fl at sum tax on soft drinks.
Th
ese taxes pushed up the price of food and 
contributed to a rise in Mexico’s infl ation rate at a 
time when poverty was increasing in the country. 
Th
e top 10% of income earners in Mexico spend less 
than a quarter of their disposable income on food. 
Th
is contrasts with the 50% spent by the half of the 
population with the lowest income.
1
Defi ne a fl at sum tax.
2
Explain why imposing a tax on public transport 
may increase a country’s infl ation rate.
3
What 
eff ect would a reduction in poverty be likely 
to have on food’s weighting in Mexico’s consumer 
price index?
4
Discuss whether imposing a tax on food would 
increase poverty.
Figure 5.3 
Non-inflationary economic growth
Price level
Real GDP
0
P
AD
AD
AD
1
AD
1
AD
2
AD
2
AS
1
AS
2
AS
Y
1
Y
2
Y
The eff ectiveness of policies to correct demand-
pull inflation
Raising income tax to reduce demand-pull infl ation may 
backfi re. Th
is is because workers may seek higher wages to 
maintain their disposable income. If their wage claims are 
granted, fi rms’ costs of production may increase. Higher costs 
can generate cost-push infl ation. Higher income tax rates may 
also, as noted earlier, create disincentive eff ects. Some workers 
may respond to a reduction in disposable income by leaving 
the labour force. Th
is will reduce the economy’s productive 
capacity and so reduce aggregate supply.
Th
ere are a number of reasons why a rise in the rate 
of interest may not discourage consumer expenditure. 
Commercial banks usually do keep their interest rates in 
line with the central bank’s as it is the rate they will have 
to pay if they need to borrow from the central bank. Th
ere 
is, however, no guarantee that they will always raise their 
interest rates when the central bank increases its rate. 
Even if consumers are faced with higher interest rates, 
they may not reduce their spending if they are optimistic 
about the future. (Th
e same applies to a rise in income 
tax where households may cut their saving rather than 
their spending if they think their incomes will rise in 
the future.)