With reference to the inflation graph, describe the problems an economy would face, if

inflation were to reach levels greater than 10%.

If inflation rates were to reach levels greater than 10%, the effects on the economy would be
catastrophic, with economic growth decelerating, loss in money value and the economy will soon
fall into a massive recession. Typical inflation rates (fig 2) averages between 2% and 3%, and if
inflations rates were to suddenly spike over 10%, consumer spending will dramatically decrease
due to the fact that their income can't purchase the same as much as it once did, as well as the fact
that income doesn't increase along with inflation (decrease in purchasing power and money value).
For example, prior WW2, Germany experienced hyperinflation to such an extent, where one
women, used money as firewoods because money lost half its value over one day, making it cheaper
to use than actual firewood. Alongside this, with the sudden increase in inflation and the general
price in goods and services, the insecurity in the economy will result in a large drop in consumer
confidence resulting in a massive frenzy within the community to begin saving. This massive
decrease in consumer spending, along with its saving frenzy will severely affect the economy
leading to a massive recession in the economy. In summary, the effects the economy would face if
inflation rates were to reach levels greater than 10% would be massive deceleration in economic
growth, loss in money value, decrease in consumer spending and confidence as well as an impeding
recession in the economy.

Explain how changes in interest rates can impact the circular flow of income.
When interest rates fluctuate, the circular flow of income can be affected in a variety of ways. This
circular flow of income is a term used to refer to the cycle of which income or money flows
throughout the economy. The Bank of Australia controls the level of which interest rates fall or rise.
When economy is expanding rapidly, the Bank Australia will increase the interest rates in order to
deter consumer spending. When interest rates are high, consumers normally find saving appealing
as they would earn a higher interest off the bank, however the higher interest rates also deters
consumers from borrowing moneys. This in turn, hinders the flow of the CFOI, as it reduces the
profits of business, which in turn results in less production and labour, which leads to lower rates of
income. However, if the economy isn't expanding as the Bank of Australia likes, interest rates
would fall, resulting in the opposite effects of high interest rates. Fluctuations in interest rates also
impact the CFOI as it increases or decreases the value of investments and funds. When interest
levels are high, shares and funds will increase in value. This increase in value provides an
alternative sources of income, which encourages consumer spending, which in turn stimulates the
CFOI. However when interest rates are low, shares and funds decrease in value, which deters
consumer spending, which in turn hinders the flow of the CFOI. Therefore, fluctuations in interest
rates can seriously affect the circular flow of income.