Inflation • Definition: – Is a steady an upward movement in the level of prices decreasing purchasing power over a period of time, usually one year.2
Hyper inflation• Extremely rapid or out of control inflation.• Hyperinflation is a situation where the price increases are so out of control that the concept of inflation is meaningless.
Deflation• A general decline in prices, often caused by a reduction in the supply of money or credit.• Deflation can be caused also by a decrease in government, personal or investment spending.• The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression.
Stagflation• A condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, or inflation.• Stagflation occurs when the economy isnt growing but prices are, which is not a good situation for a country to be in.
How to measure inflation?• The rate of price inflation in an economy is measured by calculating the average percentage change in the price of all goods and services, from one point in time to another, say one month/year.
Measuring Inflation• The Consumer Price Index (CPI) is the official measure of inflation.7
Measuring Inflation • The CPI can be thought of as an imaginary ‘basket’ of selected goods and services bought by a typical capital city household. • The CPI is merely a measure of the changes in the price of this basket of goods and services.8
Measuring Inflation • The price of the CPI basket in the base (first) period is given a value of 100 and the prices of subsequent periods are compared against the base year.9
Measuring Inflation• For example, if the price of the basket had increased 15% since the base year, the CPI would read 115, if the price had fallen by 15% since the base year the CPI would be 85.10
Uses of CPI data• As an economic indicator:• Measure of changes in cost of living.• Govt. can control price inflation using macro economic policies.• Workers seek increase in wages by looking at the CPI.• Entrepreneurs makes business decision…
Uses of CPI data• As a price deflator:• Rising prices reduce purchasing power or real value of money.• CPI is used to deflate these values and calculate real or inflation- free values.• Eg: Wage increased by 10%; price inflation is 15%; then the real value of wages fallen by 5%
Uses of CPI data• Indexation:• Indexation involves tying certain payments to the rate of increase in CPI.• Ex: pensions indexed with CPI means they increase by the rate of inflation.• Other examples: Savings, threshold of income tax etc
Types of goods and Proportion of Average price of Weighted averageservices weekly income goods and services price spent on each categoryTravel and Leisure 15% $20.00 0.15x$20.00=$3.00Household goods 25% $40.00and servicesClothing and 40% $30.00footwearTransport 20% $25.00 Total 100%
How to calculate CPITypes of goods and Proportion of Average price of Weighted averageservices weekly income goods and services price spent on each categoryTravel and Leisure 25% $22.00 0.25x$22.00=$5.50Household goods 25% $46.00and servicesClothing and 35% $38.00footwearTransport 15% $20.00 Total 100%
Problems with price indices• Over time, “typical” household and “basket” of goods will tend to change.• Over time, quality of goods and services and sources of purchase also may change.• International comparison is difficult.(household composition and spending patterns differ between countries)• Exclusion of food, energy, house prices and income taxes may give only inaccurate data.
What causes inflation?1. Over money supply:• “Too much money chasing too few goods.”• People are able to increase their spending on goods and services faster than producers can supply goods and services they want to buy.
• Govt. may allow the supply of money to increase by: A. issuing more notes and coins B. Allow banking system to create more credit• Govt. may expand the money supply: To increase total demand and reduce unemployment. In response to an increase in demand for G & S In response to demand for higher wages and rise in cost of production.
What causes inflation?• 2. Monetary rule:• If the government wants to keep inflation low and stable, it should allow the supply of money to expand at the same rate as the increase in real output or real GDP over time.
What causes inflation?• 3. Government policy: Measures to boost demand and to reduce unemployment, governments allow money supply to expand.• Inflation reduced purchasing powerDemand for higher wages unemployment =
What causes inflation?• 4. Demand-pull Inflation: Inflation caused by increase in total demand is called demand-pull inflation. In aggregate demand borrowing/issue of new currency more money supply Inflation
What causes inflation?• 5. Cost push inflation:• Inflation caused by higher cost feeding into higher prices is called cost-push inflation.• Wage-price spiral: As price demand for wages cost price.
Fill in the blank boxes to complete the wage-price spiral
What causes inflation?• 6. Imported inflation: Rising prices in one country may be exported to other countries through international trade. This is called imported inflation. A fall in the value of one currency against another currency can also lead to imported inflation.($1=Rs.50) falls to ($1=Rs.25)• ($10 worth import now costs $20)
Rising prices reduce the purchasing power of people’sincomes.(Their real income falls)Pensioners & Government employees(fixed incomegroup)Professional people and workers in strong tradeunions.(better bargaining power)People who save money(If interest rate is rate ofinflation becomes worse off)Old age pensioners other fixed income earnersGovernment earns more tax revenue.
Cost of inflation to the economy• Inflation causes unemployment.o People save more in times of high inflation.o More imports and less exports.• Reduction in the real value of savings• International competitiveness
Employment• Employment provides people with income and wealth.• Unemployment wastes productive resources. Hence:• Governments always wants to maintain a high and stable level of employment.
Employment Indicators Labour force Employment Employment UnemploymLabour participation by industrial status ent force rate sector
Key Employment Indicators• Labour force: Total number of people of working age in work or actively seeking work• Labour force participation rate: The labour force as a proportion of the total working age population.• Employment by industrial sector: How many people work in agriculture and manufacturing industries, relative to services.• Employment status: The number of people employed full-time, part time or temporary work.• Unemployment: The number of people registered as being without work, and as a proportion of the total labour force(the unemployment rate)