Beruflich Dokumente
Kultur Dokumente
Contents
What is inflation: meaning
Effects of inflation
Examples of inflation
INFLATION
Inflation is nothing
more than a sharp upward rise in price level. Too much money chasing, too few goods. Inflation is a state in which the value of money is falling i.e. prices are rising.
Theories of inflation
Demand-pull
Demand-pull inflation
Demand-pull inflation happens where there is 'too much
money chasing too few goods'. Excessive growth in demand literally pulls prices up.
Demand-pull inflation happens when the level of aggregate
demand grows faster than the underlying level of supply. This may be easier to imagine, if you think of supply as the level of capacity. If our capacity to produce is growing at 3%, and the level of demand grows at the same rate or slower then we don't have a problem. We can produce all we need. However, if our capacity grows at 3%, but demand grows faster, then we have a problem. In effect we have 'too much money chasing too few goods', and we can't manage to produce all we need. Something has to give, and it is prices that are forced up, therefore causing inflation. We can see all this in the diagram below. As the aggregate demand curve shifts to the right, the price level rises inflation.
5
Demand-pull inflation
Cost-push inflation
If costs rise too fast, companies will need to put prices up to
aggregate demand. It is important to look at why costs have increased, as quite often costs are increasing simply due to the economy booming. When costs increase for this reason it is generally just a symptom of demand-pull inflation and not cost-push inflation. For example, if wages are increasing because of a rapid expansion in demand, then they are simply reacting to market pressures. This is demand-pull inflation causing cost increases.
However, if wages rise because of greater trade union power
pushing through larger wage claims - this is cost-push inflation. The aggregate supply curve shifts left because of the cost increase, therefore pushing prices up.
7
Cost-push inflation
So why might costs get pushed up, causing inflation?
If trade unions gain more power, they may be able to push wages up independently of consumer demand. Firms then face higher costs and are forced to increase their prices to pay the higher claims and maintain their profitability.
Profits
If firms gain more power and are able to push up prices independently of demand to make more profit, then this is considered to be cost-push inflation. This is most likely when markets become more concentrated and move towards monopoly or perhaps oligopoly.
Cost-push inflation
Exhaustion of natural resources
As resources run out, their price will inevitably gradually rise. This will increase firms' costs and may push up prices until they find an alternative source of raw materials (if they can). This has happened with fish stocks. Over-fishing has put many types of fish and fish-based products under extreme pressure, forcing their price up. In many countries equivalent problems have been caused by erosion of land when forests have been cleared. The land quickly becomes useless for agriculture.
Taxes
Changes in indirect taxes (taxes on expenditure) increase the cost of living and push up the prices of products in the shops. An example would be when the level of service tax was increased.
9
Cost-push inflation
Imported inflation
We now work in a very global economy and many firms import a significant proportion of their raw materials or semi-finished products. If the cost of these increases for reasons out of our control, then once again firms will be forced to increase prices to pay the higher raw material costs.
10
Cost-push inflation
11
this theory, and this theory was in turn derived from the Fisher Equation of Exchange. This equation says that: MV = PT where: M is the amount of money in circulation V is the velocity of circulation of that money P is the average price level, and T is the number of transactions taking place
12
of the money stock times the rate at which it is used for transactions will be equal to the number of those transactions times the price of each transaction. It will always be true, as it simply says that National Income will be equal to National Expenditure and basic macroeconomics tells us that this is true anyway. So nothing stunning there! However, what makes it important is what classical economists predicted from it. Classical economists suggested that V would be relatively stable and T would always tend to full employment. Therefore they came to the conclusion that: In other words increases in the money supply would lead to inflation. The message was simple; control the money supply to control inflation.
13
Phillips Curve
The Phillips Curve is a relationship between unemployment
and inflation discovered by Professor A.W.Phillips. The relationship was based on observations he made of unemployment and changes in wage levels from 1861 to 1957. He found that there appeared to be a trade-off between unemployment and inflation, so that any attempt by governments to reduce unemployment was likely to lead to increased inflation.
The curve sloped down from left to right and seemed to
offer policy makers with a simple choice - you have to accept inflation or unemployment. You can't lower both. Or, of course, accept a level of inflation and unemployment that
seemed to be acceptable!
14
Phillips Curve
15
1 6
reasons of inflation is excess public expenditure like building of roads ,bridges etc. Government should drastically scale down its non essential expenditure.
B-Delay in payment of old debts: Payment of old debts
that fall due should be postponed for sometime so that people may not acquire extra purchasing power.
C-Increase in taxes : Government should levy some new
Other measures 1 Increase in the production- One of the major causes of the inflation is the excess of demand over supply ,so those goods should be produced more whose prices are likely to rise rapidly .In order to increase production public sector should be expanded and private sector should be given more incentives. 2 Proper commercial policy- Those goods which are in scarcity should be imported as much as possible from other countries and their export should be discouraged. 3 Encouragement to savings During inflation government should come out with attractive saving schemes. It may issue 5 or 10 year bonds in order to attract savings.
How is it Measured?
Consumer Price Index Wholesale Price Index
2 0
consumer goods and services purchased by households. CPI measures a price change for a constant market basket of goods and services from one period to the next within the same area (city, region, or nation). It is a price index determined by measuring the price of a standard group of goods meant to represent the typical market basket of a typical urban consumer. The percent change in the CPI is a measure estimating inflation.
2 1
2 2
the economic indicators available to policy makers until it was replaced by most developed countries by the CPI market. index in the 1970. WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. Some countries (like India and The Philippines) use WPI changes as a central measure of inflation.
economy. Consumers are spending loads of money on services like education and health. And these services are not incorporated in calculation of WPI. WPI measures general level of price changes either at level of wholesaler or at the producer and does not take into account the retail margins. Therefore we see here that WPI does give the true picture of inflation. WPI is supposed to measure impact of prices on business. But we use it to measure the impact on consumers. Many commodities not consumed by consumers get calculated in the index.
2 3
2 4
Inflation rate
PI for a certain year - PI for a comparative year PI for a comparative year X 100
2 5
INFLATION RATES
2006-2007 Inflation Food inflation 7.8 10.3 2007-2008 12.0 17.6
Non-food inflation
6.2
6.8
2 6
EFFECTS OF INFLATION
They add inefficiencies in the market, and make it
difficult for companies to budget or plan long-term. Uncertainty about the future purchasing power of money discourages investment and saving. There can also be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable inflation. Higher income tax rates. Inflation rate in the economy is higher than rates in other countries; this will increase imports and reduce exports, leading to a deficit in the balance of trade.
2 7
EXAMPLES OF INFLATION
Increase in the price of wheat
2 9