ECONOMICS ASSIGNMENT COVER'S THE TOPIC INFLATION.. hit LIKE if it helped you. :) would mean alot!

1. 2013
Submitted By: Afrah A.Sheikh
Submitted To : Mrs. Narmeen Nasr
Student ID:
ECONOMICS ASSIGNMENT
SUBJECT MODULE: W1006

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TABLE OF CONTENTS
1. What is Inflation? ………………………….…………………………3
2. The causes of Inflation…………………………………………..… 3
3. Causes of Inflation in a Country……………………………........….8
4. Explanation of the effects of Inflation……………………………...10
5. The ways in which Inflation can be curbed……………………..….11
6. References……………………………………………………………12
Inflation

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 Introduction to Inflation:-
Inflation can be defined as a generalised and persistent increase in the level of
prices In simple words it is a general increase in prices and fall in the purchasing
value of money. It is regarded as the most important issue in Economics.
Inflation is measured by the changes in the retail price index (RPI) which
records the changes in the general level of prices paid by consumers for all the
goods and services they buy. When inflation crosses reasonable limits, it has
negative effects. It reduces the value of money, resulting in uncertainty of the
value of gains and losses of borrowers, lenders, and buyers and sellers.
Therefore, the increasing uncertainty discourages saving and investment.
 Causes of Inflation:-
Inflation is the devasting condition when prices just keep going up, eating away
the standard of living.
There are three main causes of inflation:
 Demand-Pull Inflation
 Cost – Push Factor
 The monetarist view of inflation.
 Demand- Pull inflation: By the name itself it means that there
is too much demand in the economy which exceeds supply of goods and
services and therefore prices are pulled up. This situation is usually,but
not always associated with full employement in the economy. This is
usually explained by the phrase “too much mo ney chasing too few goods”.

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Economists often say that demand-pull inflation occurs when price levels
rise because of an imbalance in the aggregate supply and demand. When
the aggregate demand in an economy strongly outweighs the aggregate
supply, prices increase. This occurs when there is excess aggregate
demand in the overall economy or in a specific market or industry.
Businesses respond to high demand by raising prices to increase their
profit margins. Demand-pull inflation is associated with the boom phase
of the business cycle. The main causes of demand pull inflation are:
1. Faster rates of economic growth in other countries – providing a boost to
UK exports overseas
2. A weaker exchange rate which increases the price of imports and reduces
the foreign price of UK exports
3. Rising consumer confidence and an increase in the rate of growth of house
prices
4. A reduction in direct or indirect taxation - consumers have more
disposable income causing more demand
5. Rapid growth of the money supply as a consequence of increased bank
and building society borrowing
 Cost – Push Factor: Cost push inflation is inflation caused by an
increase in prices of inputs like labor, raw material, etc. The increased
price of the factors of production leads to a decreased supply of these
goods. While the demand remains constant, the prices of commodities

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increase causing a rise in the overall price level and the overall price level
increases due to higher costs of production which reflects in terms of
increased prices of goods and commodities which majorly use these
inputs. This is inflation triggered from supply side i.e. because of less
supply. Apart from rise in prices of inputs, there could be other factors
leading to supply side inflation such as natural disasters or depletion of
natural resources, monopoly, government regulation or taxation, change in
exchange rates, etc. Generally, cost push inflation may occur in case of an
inelastic demand curve where the demand cannot be ea sily adjusted
according to rising prices. This is in essence cost push inflation, it is a
situation where rising costs “push up” prices.
This occurs when costs of production or operation are increasing. The
main key causes include:
1. Acceleration in wages
2. External shocks (e.g. commodity price fluctuations)
3. A depreciation in the £ exchange rate i.e. the more the weaker the
pound the more expensive are the goods.
 The monetarist view of inflation: A set of views based
on the belief that inflation depends on how much money the
government prints. Monetarists often argue that if the Money
Supply rises faster than the rate of growth of national income then
there will be inflation. Tight control of money and credit is
required to maintain price stability. The key is for monetary policy

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to be credible – in the hands of an independent central bank – so
that people’s expectations of inflation are controlled
A simple way of explaining how a surge in the amount of money in
circulation can feed through to higher inflation is shown in the flow
chart below.
Excess money balances held by households and businesses can affect demand
and output in several directions. Consumers will increase their own demand for
goods and services adding directly to aggregate demand. Some of the excess
balances will be saved in bonds and other financial assets, or invested in the
housing market. An increase in the demand for bonds causes a downward
movement in bond interest rates as there is an inverse relationship between the
two and this can then stimulate an increase in investment. Money that flows into
housing will push house prices higher, and knowing that might understand quite

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well how a booming housing market stimulates consumer wealth, borrowing and
an increase in spending.
 The Quantity Theory of Money By Famous Economist:
The theory rests on what is sometimes known as the Fisher identity as it was
known and first developed by Irving Fishe r or the equation of
exchange. This is an identity which relates total aggregate demand to the total
value of output (GDP).
M x V = P x Y
Where
 M is the money supply
 V is the velocity of circulation of money
 P is the general price level
 Y is the real value of national output (i.e. real GDP)
Money supply (M) multiplied by the velocity of circulation (V) = the
value of national output (price level (P) x volume of transactions (Y))
 Velocity of circulation can be calculated by dividing the money
value of national output by the money supply and it represents the number
of times that a unit of currency (E.g. a £10 note) is used in a given period
of time when used as a medium of exchange to buy goods and services
Inflation in Pakistan: In Pakistan the general price level is
persistently rising since its establishment. The prices remained volatile
during the decade of 1990’s ranging from 5.7 % to 13 % mainly because
of declining economic growth, expansionary prices, output setbacks,
higher taxes and a depreciation of Pakistan rupee.

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The inflation rate started declining from 1998 onward due to improved
supply position of goods and strict budgetary measures. The inflation
rate was 5.7 % in 1998-99. It was brought down to 3.6 % in 1999-2000
and further to 3.1 % in 2002-2003. The inflation rate based on CPI
(Consumer Price Index) has averaged 4.6 % during 2003-2004. The slight
rise in prices was due to increase in price of wheat. The inflation
rate reached as high as 9.3% in the year 2004-2005 mainly due to rise in
price of wheat and increase in the international oil price.
Demand Pull Inflation in Pakistan:
 Demand for non-deve lopment expenditure s : The elected and
non-elected governments in Pakistan since 1947 have not been able
to curb the non-development expenditures.
 Rapid mone tary expans ion: From the past years the growth in
monetary assets has outstripped the rise in nominal GDP. The easy
monetary policy adopted to kick start the stagnant economy has led
to the rise in general price level.
 Fore ign Economic as s is tance : For rapid economic
development, Pakistan has been receiving foreign and since early
50’s. The output of goods, therefore does not increase
correspondingly with the rise in income.
 Consumption habits : Pakistanis living in Urban and rural areas are
mostly send thrift. They are proud of spending money on the goods
which are used by the people in the advanced countries of the
world. The increased expenditure on clothes, foods, cosmetics etc.
have added much to the inflationary pressure in the country.
 Cons truction of house s : people are spending their savings mostly
on the purchase of land and construction of houses. The
unproductive expenditure on the construction of houses, plazas etc.
has also contributed to the rising trend in prices.

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 Increase in Wage s : The rise in wages, salaries, dearness
allowances, bonuses etc. in the annual budget increase the
purchasing power of the employees. With the increase in the
disposable income of the workers, the prices of the commodities go
up. The workers gain press for higher wages.
 Black Money: Black money is the unaccounted money receipts. It
is generated through smuggling, tax evasion, price control etc. It is
estimated that annual generation of black money is about 25% of
GNP of the country. This huge amount pushes up the prices of land,
houses, cars, air conditioners and other expensive items.
Cost-Push Factor of inflation in Pakistan:
 Increase in Indire ct taxe s : For increasing the revenue the
Government is heavily relying on indirect taxes. The increase in the
indirect taxes every year has given the general price level an
inflationar y push.
 Depre ciation of Rupe e : The repeated and higher devaluations of
Pakistani rupee has increased the cost and prices of imported
goods. Depreciation of the currency thus is an important factor for
the rise in the average level of prices in Pakistan.
 Rise in Gas and Excise Duty: The multiplier effect of the rise in
gas prices, and levying of excise duty, sales tax on a number of
items has greatly contributed to the cost push effect.
 Rise in support price of agriculture crops : The Government
raises the support prices of cotton, wheat, sugar cane to protect the
interests of farmers. This also has an inflationary impact on
the currency.
 Increase in Wage s : In Pakistan one of the factors leading to cost-push
inflation in the rise in wage not backed by increase in
productivity. The compensatory wage increase and the rise in
prices are chasing each other at quite a rapid speed causing
personal rise in the level of prices.

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 Ris ing price s of imported goods : The import prices of POL
chemicals, fertilizers, non-electrical machinery etc have gone up in
the world market. The cost and so the price of commodities using
the imported items has gone up in the country.
 Effects of Inflation:-
Inflation effects the different sectors of the economy such as on the distribution
of income ,wealth, production, Government, balance of payment, monetary
policy, social sector, political environment and different classes of the people
such as debtors & creditors, salaried class, wages earners, fixed income group,
additionally investors, shareholders, businessmen, agriculturists etc.
Inflation has other disastrous effects and can be very damaging for a number of
reasons. Initially people may be left worse off if prices rise faster than their
incomes. Never the less, inflation can reduce the value of an investment if the
returns prove insufficient to compensate them for inflation. If money is losing its
value, businesses and investors are less likely to make long- term contracts. This
discourages long- term investment in the nation’s productive capacity. Precisely,
local spending, indeed, does get a shot in the arm. The new money works its
way, step by step, throughout the economic system. As the new money spreads, it
bids prices up and in the meantime, some people gain and other people lose.
In short, the counterfeiters and their local retailers have found their incomes
increased before any rise in the prices of the things they buy. But, on the other
hand, people in remote areas of the economy, who have not yet received the new
money, find their buying prices rising before their incomes. Retailers at the other
end of the country, for example, will suffer losses. The first receivers of the new
money gain most, and at the expense of the latest receivers. Inflation, then,
confers no general social benefit; instead, it redistributes the wealth in favor of
the first-comers and at the expense of the laggards in the race.

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 Ways in which Inflation can be
curbed:-
Inflation always hurts ones standard of living. Rising prices mean people have to
pay extra for the same goods and services. If income increases at a slower rate as
inflation, the standard of living declines even if one makes more so it is the root
cause in making and affecting economy and people of the country poor. If we
want to control inflation we shall have to inflict strict control over the supply of
money and evading any relaxation to the supply of money by making imports
cheaper, reducing demand for exports and increasing incentive for exporters to
cut costs. The government can increase taxes such as income tax and cut
spending. This improves the budget situation and helps to reduce demand in the
economy which reduces the inflation by the growth of an aggregate Demand. In
some cases, the economy seems to be growing reasonably strongly. Therefore,
the inflationar y pressures can be reduced without causing a recession
In addition Lower wage growth helps to reduce cost push inflation, and helps to
moderate demand pull inflation then limiting wage growth can help to moderate inflation.
Besides, monetarism seeks to control inflation through controlling the money supply.
Monetarists believe there is a strong link between the money supply and inflation. It is
although believed that inflationary pressure can be reduced by more flexible labor.

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 References:-
1. http:/ /c lausvis te sen.squarespac e.com/a lphasourc es -
blog/2007/7/21/pr ice-mea surement- in- japan.html
2. http:/ /www.tutor2u. net /blog/ index.php/bus ines s -
studie s /comments /qa-expla in- the-causes-of- inf la t ion
3. http:/ /economic t ime s. india t imes .com/de fini t ion/cost -push- inf la t ion
4. http:/ /www. inves topedia.com/ te rms /m/moneta r ism.a sp
5. http:/ /www.tutor2u. net /e conomics / revis ion- notes /a2-mac ro-moneta
r ism.html
6. http:/ /wiki.answe r s.com/Q/Wha t_are_the_ma in_Causes_of_inf la t ion
_in_Pakis tan_in_recent_t ime
7. http:/ /note s forpakis tan.blogspot. com/2009/08/cause s -of-infla
t ion.html
8. http:/ /www.economic she lp.org/blog/2269/economic s/ways - to-reduce-
inf la t ion/
9. http:/ /pakobse rver .net /de ta i lnews. asp? id=136097
10. http:/ /pakis tant ime s.ne t /pt /de ta il.php?news Id=12410