Inflation and Its Effect on Economy

Inflation and Its Effect on Economy

inflation refers to an economic indicator that shows the increasing prices of goods and services. Inflation is measured using the consumer price index (CPI). The three major components to be discussed in this article are the types of Inflation witnessed in the economy: Demand-pull Inflation, Cost-push Inflation, and Built-in Inflation. The level of Inflation in the economy highly affects the buying behaviors of individuals, as people tend to buy goods when the price is low compared to when prices are high. The buying behavior of consumers is that they tend to buy more of a product when they anticipate a change in the price of the product shortly that is increasing in price. A high inflation rate means the value of the currency used in trading has decreased, thus lowering its purchasing power. There are various causes of Inflation, such as increased money supply; this is where a lot of money is circulating in the economy, meaning that demand for goods and services will be high. Secondly is an increase in wages for the workers. An increase in income by workers means that they will have a high demand for goods by changing their spending behaviors. Policies and regulations are also other factors that cause Inflation. When the government or a state issue subsidy on the production of a particular good or service, this can increase the demand for that product; when the demand becomes higher than the supply, it refers to a rise in the price of the product, thus causing Inflation.

The first type of Inflation to be discussed in this article is demand-pull Inflation. This type of Inflation is where consumers’ demand for goods and services is higher than the supply in the market. This means that the price of the products will automatically shoot up, thus causing demand-pull Inflation. The difference between the demand and supply cause price increase.

Several factors cause demand-pull Inflation. Firstly is the future anticipated shortage of goods by consumers? This means consumers will want to buy the product in large quantities now to use it in the future. Thus this causes demand-pull Inflation.

Secondly are lower interest rates; a decrease in interest rates causes a rise in consumer spending behaviors and increased economic investment. The other factor is a rise in house prices. This creates a wealth impact and increases consumer spending. Higher wage rates among workers can also act as a factor causing demand-pull Inflation. If trade unions bargain for an increase in wages for workers, they will have a high demand for goods and services, leading to an increase in the price of the products. The last factor that causes demand-pull Inflation is devaluation. Devaluation in the exchange rate causes domestic demand, a situation where the exports become cheap, and imports become more costly.

The second type of Inflation is cost-push Inflation. This refers to a situation where prices of goods and services are high due to an increase in the cost of production. This usually emerges from the production firms where the cost is transferred to the consumers through high prices for the final product. There are various causes of cost-push Inflation, which I shall discuss in this article. These include higher taxes; the government or state may impose higher taxes on the production of certain goods, so the production firms will have to respond by putting higher prices on the final goods to make profits or be at equilibrium. Another cause is profit-push Inflation. This occurs when a particular firm happens to be the only sole supplier of a particular product in the market, which is a monopoly market. This means it has the power to control the price of goods, so it will set a higher price for the product to continue making more profits. Higher inflations can also cause cost-push Inflation. When consumers get a high income, they tend to improve their living standards, and this usually affects their spending and buying behaviors, in which they will want to spend more on a particular good than they used to. This increased demand for this product causes a rise in price for the product rendering cost-push Inflation. The last cause of cost-push Inflation is imported Inflation. This is a situation where devaluation causes an increase in the price of imported goods. Most of the time, when devaluation occurs, it automatically increases the domestic price of imported goods, thus causing Inflation.

The last type of Inflation discussed in this article is built-in Inflation. This kind of inflation results from past events and continues to persist. Built-in Inflation emerges from either persistent demand-pull or large cost-push (supply shock) inflation in the past. This has turned out to be termed a regular aspect of the economy since it keeps on repeating itself. Built-in Inflation occurs when workers expect their wages and salaries to increase when prices of goods and services increase to help them maintain their usual living standards without any constraints. Built-in Inflation has no major causes in that it is only double-edged such that when workers demand higher salaries or wages, the cost of production increases, which renders to a higher cost of living, meaning there has been an increase in the price of goods and services due to a rise in the cost of production thus causing Inflation.

In conclusion, Inflation has several adverse effects on the economy of any country, and it should be addressed fully as it leads to a high cost of consumer goods in which many consumers cannot acquire all those goods at those prices. It also affects the investment level of a country, as high Inflation means consumers will spend all their income on buying goods to meet their living standards. The government or any state should put clear measures into place to control the inflationary rates in the entire economy.

References

 Haldane, Andrew G., 1998, “On Inflation Targeting in the United Kingdom,” Scottish Journal of Political Economy, Vol. 45, No. 1, pp. 1–32.

Perry, G.L. 1980. Inflation in theory and practice. Brookings Papers on Economic Activity 1: 207–241.

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Discussion 5.1

Inflation and Its Effect inflation

What is meant by the term Inflation? Discuss. How does it affect the economy?

MINIMUM 150 WORDS. REFERENCES ARE MANDATORY.