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INFLATION : :red_flag: defined as a sustained increase in the GPL in the…
INFLATION
: :red_flag: defined as a sustained increase in the GPL in the economy
EFFECTS of high inflation
DISTRIBUTIONAL EFFECT
Inflation results in REDISTRIBUTION OF INCOME
as some ppl will be made better off while others are made worse off:
FIXED INCOME EARNERS (e.g. wage earners, pensioners & bond holders) --> will find the REAL VALUE OF THEIR Y ERODED BY INFLATION unless such incomes can be adjusted for Price increases
WEAKLY IONIZED WORKERS who cannot gain full compensation for price rises will lose out to the strongly unionised workers who will be in a better position to protect their real Y
INTERNATIONAL UNCOMPETITVENESS
due to COST-PUSH INFLATION, domestic gds become expensive during & if the country has a higher rate of inflation than that of its trading competitors
it will have PROBLEMS WITH ITS BOP as its exports become less competitive in foreign markets
Assume PEDX>1, Quantity demanded for exports would decrease by more than proportionately --> export revenue fall
At the same time, foreign gds become more competitive in domestic markets--> a greater demand for the relatively cheaper imports & thus dd for imports increase
OVERALL CURRENT A/C WOULD WORSEN, HENCE BOP WORSEM
CAUSES
DD-PULL INFLATION :fire:
CAUSE BY EXCESSIVE AD near or at full employment level of national o/p
Excessive / continuous increase in C/I/G/X
AD curve Increases by a large extent from AD1 to AD2, the economy grows near full-employment output level rapidly and the shift takes place at the upward-sloping or vertical portion of the AS curve
Price increase from P1 to P2 and real national Y increases a little from Y1 to Yf.--> there is 'bottlenecks in production' where there is stiff competition for increasingly scarce resources-->producers pay more to obtain the desired FOP & will increase the price of their o/p to maintain profits--> THIS LEADS TO DD-PULL INFLATION
DD-PULL INFLATION IS
ACCOMPANIED BY SOME EG & FALL IN UNEMPLOYMENT
:star: :star: :star:
CYCLICAL UNEMPLOYMENT FALL :!!:
Initial dd-pull inflation may strengthen the bargaining power of strong trade unions & DRVE UP WAGE COST--> continuing rightward shift in AD curve or leftward shift of AS curve-->
PRICES CONTINUE RISING, RESULTING IN INFLATIONARY SPIRAL
:!!: :!!:
The wage-price spiral suggests that rising wages increases disposable income, thus raising the demand for goods and causing prices to rise.
COST-PUSH INFLATION
:fire:
caused by persistent rise in costs of production, for reasons not associated with an increase in demand
E.G) RISING unit LABOUR COSTS
caused by wage increases that are greater than productivity increases
E.G) RISING COST OF IMPORTED RAW MATERIALS
inflation in the countries of origin or fall in domestic exchange rate -->push up COP and price of final gd
SG very susceptible to such inflation, as there are few natural resources and heavy dependence on imported inputs of production
E.G)HIGHER INDIRECT TAXES IMPOSED BY THE GOVT
raising indirect tax ,raises domestic prices independently of the level of AD
COP increases-->reduce amt of profits--> firms respond by cutting back on production-->AS falls-->higher costs shift AS upwards at every level of national output--> HENCE GPL INCREASE
ALT. EXPLANATION: In response to rising production costs, firms will pass on some of the rise in cost to consumers in the form of higher prices--> this is shown by inward shift of AS
COST PUSH INFLATION IS
ACCOMPANIED BY BUSINESS CLOSURES & RISE IN UNEMPLOYMENT THAT IS SUPPLY SIDE IN NATURE (STAGFLATION)
:star: :star: :star:
Measures the percentage change in GPL over 2 consecutive years
using the consumer price index (CPI)
Inverse relationship between GPL and internal value of money
CONSEQUENCES OF INFLATION FROM PERSPECTIVE OF.....
CONSUMERS
:checkered_flag:
LOW ANTICIPATED INFLATION
encourages households to save more--> REAL VALUE OF SAVINGS RISE
Ppl who save money may become worse off--> in order to maintain the real value of their savings, savers must receive a rate of I/r that is at least equal to rate of inflation
Workers able to factor the effects of inflation into their wage agreement--> leads to
rise in real purchasing power
-->increase ability for households to enjoy more gds & srvs
C INCREASE
-->
SOL INCREASES
RESULTS IN REDISTRIBUTION OF Y (same as the pt above)
PRODUCERS
:checkered_flag:
if there is a dd-pull inflation & inflation is stable
signal to firms that there's a rise in dd of gds & srvs--> assume COP constant due to contractual agreement of wages/raw materials--> INCREASE IN PROFIT-->
INCREASE IN INVESTMENT-
-> RISE IN POTENTIAL & ACTUAL GROWTH--> dd for labour increases due to increase production-->
EMPLOYMENT INCREASES
if there's cost-push inflation due to rise in COP
Rising COP creates uncertainty in planning production & pricing of goods in future--> makes planning for Investment more difficult---> Firms respond by DECREASING PLANNED CAPITAL INVESTMENT SPENDING-->
LOWER INVESTMENT
--> negative effects of economy LR potential growth
GOVT.
:checkered_flag:
LOW & STABLE INFLATION
reduces uncertainty--> INSTIL CONFIDENCE FOR CONSUMERS & FIRMS--> fosters INVESTMENT
LOWERS EG IN THE LR
High cost push inflation-->rising COP + creates uncertainty--> businessman less willing to take risk associated with Investment projects--> budgeting becomes difficult, etc.... LOWERS INVESTMENT --> AD & AS fall in the LR--> NEGATIVE EFFECT ON ECONOMY'S LR POTENTIAL GROWTH & EMPLOYMENT
BOP DETERIORATE
Assume cause of inflation is due to cost push inflation--> (same as the explanation for international uncompetitiveness)
For countries with high rate of inflation--> deteriorating BOP position will eventually lead to fall in external value of currency CURRENCY DEPRECIATION
CURRENCY DEPRECIATION may create further inflationary pressure on domestic economy as Pm increases--> BOP END UP WITH HUGE DEFICIT ESP IF IMPORT IS AN ESSENTIAL COMMODITY
