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inflation
1. Inflation is defined as a rise in the general level of prices where a unit of currency buys less than it previously could. It occurs when the money supply grows faster than the economy. 2. There are three main types of inflation: demand-pull inflation caused by increased demand, cost-push inflation caused by increased costs of production, and built-in inflation caused by expectations of future inflation. 3. While inflation has some potential advantages like enabling adjustment of wages and prices, it also has disadvantages like uncertainty that reduces investment, and loss of international competitiveness from higher prices. High or hyperinflation can severely damage an economy.
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inflation
- 1. 1 University of salahaddin- Hawler College of Administration and economy Department of Banking and financial (Inflation) Prepeared by: Rawand Jumha Supervisor:Dr.Amer
- 2. 2 List of content: 1.what'sinflation? 2.understanding inflation 3.example of inflation 4.types of inflation 5.advantages and disadvantages
- 3. 3 what's inflation? Inflation isa quantitative measure of the rate at which the average price level of a basket of selected goods and services in an economy increases over some period of time. It is the rise in the general level of prices where a unit of currency effectively buys less than it did in prior periods. Often expressed as a percentage, inflation thus indicates a decrease in the purchasing power of a nation’s currency. understanding inflation As prices rise, a single unit of currency loses value as it buys fewer goods and services. This loss of purchasing power impacts the general cost of living for the common public which ultimately leads to a deceleration in economic growth. The consensus view among economists is that sustained inflation occurs when a nation's money supply growth outpaces economic growth.
- 4. 4 example of inflation Forexample, prices for many consumer goods are double that of 20 years ago. When you hear your grandparents recall, "A movie and a bag of popcorn only cost a buck- twenty-five when I was your age," they are making an observation about inflation—the rising cost of goods and services over time, and the decrease in the purchasing power of the dollar. types of inflation 1. Demand-pull Inflation - Demand-pull inflation occurs when the overall demand for goods or services increases faster than the production capacity of the economy. This type of inflation leads to a demand-supply gap (i.e., a shortage), which results in an increase in price (see also the law of supply and demand). To illustrate this, we can look at a simple supply and demand diagram. As you can see in the illustration below, an increase in demand causes the aggregate supply curve (AD) to shift to the left (i.e., up). However, the aggregate supply curve (AS) doesn’t change. Therefore, the new equilibrium price (P2) at the new intersection of AS and AD is higher than the old price (P1). Hence, as the name suggests, demand-pull inflation is caused by a shift in demand.
- 5. 5 2. Cost-push Inflation Cost-pushinflation occurs as a result of an increase in the cost of production. That is, when the prices of inputs (e.g., raw materials, labor) increase, the production of goods or services becomes more expensive, and producers need a higher price to be profitable. Going back to our supply and demand diagram, we can see that the higher input prices cause the aggregate supply curve (AS) to shift to the left, whereas the aggregate demand curve (AD) doesn’t change (see also shifts in aggregate demand). As a result, the price level increases from P1 to P2. So unlike demand-pull inflation, cost- push inflation is caused by a shift in supply. 3. Built-in Inflation Last but not least, expectations of future inflation cause built-in inflation. That means, when prices rise, workers expect (and demand) higher wages to maintain their cost of living. However, higher wages result in higher costs of production, which leads to higher prices, and the spiral begins. Because of this circular dependency, built-in inflation is sometimes also referred to as the wage-price spiral. At this point, it is important to note that the expectations that cause built-in inflation always originate from either persistent demand-pull or significant cost-push inflation in the past. In other words, built-in inflation doesn’t occur on its own. It always needs a catalyst or a trigger to kick it off..
- 6. 6 Advantage The advantages ofinflation 1. Deflation (a fall in prices – negative inflation) is very harmful. When prices are falling, people are reluctant to spend money because they feel that goods will be cheaper in the future; therefore they keep delaying purchases. Also, deflation increases the real value of debt and reduces the disposable income of individuals who are struggling to pay off their debt. When people take on a debt like a mortgage, they generally expect an inflation rate of 2% to help erode the value of debt over time. If this inflation rate of 2% fails to materialise, their debt burden will be greater than expected. Periods of deflation caused serious problems for the UK in 1920s, Japan in 1990s and 2000s and Eurozone in 2010s. 2. Moderate inflation enables adjustment of wages. It is argued a moderate rate of inflation makes it easier to adjust relative wages. For example, it may be difficult to cut nominal wages (workers resent and resist a nominal wage cut). But, if average wages are rising due to moderate inflation, it is easier to increase the wages of productive workers; unproductive workers can have their wages frozen – which is effectively a real wage cut. If we had zero inflation, we could end up with more real wage unemployment, with firms unable to cut wages to attract workers.
- 7. 7 3. Inflation enablesadjustment of relative prices. Similar to the last point, moderate inflation makes it easier to adjust relative prices. This is particularly important for a single currency like the Eurozone. Southern European countries like Italy, Spain and Greece became uncompetitive, leading to large current account deficit. Because Spain and Greece cannot devalue in the Single Currency, they have to cut relative prices to regain competitiveness. With very low inflation in Europe, this means they have to cut prices and cut wages which cause lower growth (due to the effects of deflation). If the Eurozone had moderate inflation, it would be easier for southern Europe to adjust and regain competitive without resorting to deflation. 4.Inflation is better than deflation. The only thing worse than inflation, joke economists, is deflation. A fall in prices can cause an increase in the real debt burden and discourage spending and investment. Deflation was a factor in the Great Depression of the 1930s.. Disadvantage 1.High inflation rates tend to cause uncertainty and confusion leading to less investment. It is argued that countries with persistently higher inflation, tend to have lower rates of investment and economic growth. 2.Higher inflation leads to lower international competitiveness, leading to fewer exports and a deterioration in the current account balance of payments. In a fixed exchange rate, e.g. the
- 8. 8 Euro – thisis even more problematic as countries do not have the option of devaluation. 3.Inflation can reduce the real value of savings, which might particularly affect old people who live on savings. However, it does depend on whether interest rates are higher than the inflation rate. 4.Hyper-inflation can destroy an economy. If inflation gets out of hand, it can create a vicious cycle, where rising inflation, causes higher inflation expectations, which in turn pushes prices even higher. Hyper-inflation can wipe out the savings of the middle-classes, and redistribute wealth and income towards those with debt and assets and property.
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