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Choose the right answer from the given options.
Important for :
1
During periods of inflation, tax rates should 
» Explain it
A
The tax rate should be increased during periods of inflation.
 
Inflation: The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling, is known as Inflation.
 
Hence, the option A is correct.
 
» Explain it
A
The Payment of dearness allowance to employees is one of the major reasons for cost push inflation.
 
About Cost Push Inflation:
 
Cost-push inflation occurs when firms respond to rising costs, by increasing prices to protect their profit margins.
There are many reasons why costs might rise:
 
Component costs: e.g. an increase in the prices of raw materials and other components. This might be because of a rise in commodity prices such as oil, copper and agricultural products used in food processing. A recent example has been a surge in the world price of wheat.
 
Rising labour costs - caused by wage increases, which are greater than improvements in productivity. Wage costs often rise when unemployment is low because skilled workers become scarce and this can drive pay levels higher. Wages might increase when people expect higher inflation so they ask for more pay in order to protect their real incomes. Trade unions may use their bargaining power to bid for and achieve increasing wages, this could be a cause of cost-push inflation.
 
Expectations of inflation are important in shaping what actually happens to inflation. When people see prices are rising for everyday items they get concerned about the effects of inflation on their real standard of living. One of the dangers of a pick-up in inflation is what the Bank of England calls “second-round effects" i.e. an initial rise in prices triggers a burst of higher pay claims as workers look to protect their way of life. This is also known as a “wage-price effect".
 
Higher indirect taxes – for example a rise in the duty on alcohol, fuels and cigarettes, or a rise in Value Added Tax. Depending on the price elasticity of demand and supply for their products, suppliers may choose to pass on the burden of the tax onto consumers.
 
A fall in the exchange rate – this can cause cost push inflation because it leads to an increase in the prices of imported products such as essential raw materials, components and finished products.
 
Monopoly employers/profit-push inflation – where dominants firms in a market use their market power (at whatever level of demand) to increase prices well above costs.

Hence, the option A is correct.
 
» Explain it
D
Postponing the public expenditure would result in the decrease of demand so it’s an incorrect option because it’s not a supply side measure. Increase in taxation would also leave lesser money with the people to spend, option ‘C’ absolutely wrong thus making it a supply side measure. Correct option is ‘D’ only.
 
Supply side policies seek to increase productivity, competition and innovation – all of which can maintain lower prices. These are ways of controlling inflation in the medium term:
 
1. A reduction in company taxes to encourage greater investment.
 
2. A reduction in taxes which increases risk-taking and incentives to work – a cut in income taxes can be considered both a fiscal and a supply-side policy.
 
3. Policies to open a market to more competition to increase supply and lower prices.
 
4. Maintaining price levels through an effective Public Distribution System (PDS).

Hence, the option D is correct.