Inflation
the sustained rise in the general level of prices of goods and services over time, as measured by a
consumer price index.
Inflation Throughout the Ages: watch video
Some goods may see higher price jumps
Not all prices increase equally
Others might remain stable or decrease
Measuring Inflation (CPI)
Basket of goods
Weigthage of each category of goods
Consumer Price Index
Weighted price of base year and current year
Comparison of prices - calculate the percentage difference
Types of inflation
Occurs when aggregate demand (AD) exceeds
aggregate supply (AS).
Increased consumer spending, government
Demand-pull inflation Causes
expenditure, exports, or investment.
An economic boom leading to rising wages and
Example
consumer demand.
Occurs when rising costs of production push up prices.
Higher wages, rising raw material costs, import
Causes price increases due to exchange rate depreciation,
or supply shocks (e.g., oil price hikes).
Cost push inflation
An increase in fuel prices causing transportation and
production costs to rise.
An increase in fuel prices causing transportation
Example
and production costs to rise.
Occurs when the cost of imported goods increases due to
exchange rate depreciation.
Imported inflation
A fall in the domestic currency makes imports
Example more expensive, increasing the cost of goods
that rely on imported inputs.
Extreme inflation where prices increase rapidly, often due to excessive
money supply.
Hyperinflation
Zimbabwe in the 2000s experienced hyperinflation
exceeding millions of percent.
Example
watch video
Measured using the Consumer Price Index (CPI).
A basket of commonly purchased goods
1
is selected.
Measuring inflation
Prices of these goods are monitored
2
over time.
Steps in CPI Calculation
Weights are assigned to goods based
3 on their importance in consumer
spending.
The price changes are aggregated to
4
calculate the inflation rate.
Increase in money supply without a corresponding rise in output.
Excess demand in the economy.
Causes of Inflation Rising costs of production.
Depreciation of the national currency.
Government policies such as excessive borrowing and spending.
Consequences of Inflation to Firms
Encourages borrowing and investment.
Positive Effects Reduces the real value of debt.
Firms may experience higher profits.
Negative Effects
Menu costs
Cost of changing prices and updating menus/catalogs
Prices need adjustment due to inflation
Time-consuming for businesses
Increases operational expenses of a business
Can affect competitiveness
Shoe leather costs
firms spend more time searching for cheaper alternatives / materials
physically visiting
various suppliers Opportunuity time can be spent on making
costs more sales
online searches
Leads to uncertainty, discouraging investment.
Can lead to a wage-price spiral (workers demand higher wages, causing costs to rise).
Consequences of Inflation to Consumers
Purchasing power decreases Real income falls - Money worth less than before
Savings
erosion
Cost of More money needed for Altered
Financial
living the same goods and spending
Strain
rises services habits Reduced
standard of
living
Consequences of Inflation to Different groups of people
reduced purchasing power
Savers Lose out money saved worth less
reduced investment funds
available →
may decrease
economics growth
reduced profitability
money lent out
lenders Lose out
decreases in value
reduced available funds for
investments
value of reduce
Borrowers Gain borrowing real value reduced financial stress
decreases of debt
Fixed income earners real income decreases purchasing power decreases
Struggle to absorb higher
costs
Lower income earners limited financial flexibility Increased financial strain
Difficulty in meeting basic
needs
Higher domestic prices affect export prices →
loss of price-competitive
advantage
Exporters
Lower profitability due to decreased demand
reduced export
earnings
Lower economic growth & Increased
unemployment
shrinking profit margin
workers demand pay Increased
rises to maintain real cost of
income production potential wage-price
spiral
Employers
inflation leads to uncertainty →
decrease business confidence →
Reduce investment → economic slowdown
Policies to control inflation
Government increases taxes to reduce disposable
income and demand.
Contractionary fiscal policy
Cuts government spending to decrease demand.
Central bank increases interest rates to reduce
borrowing and spending.
Contractionary monetary policy
Reduces money supply to lower aggregate demand.
Policies to improve productivity and efficiency (e.g.,
better infrastructure, education).
Supply-side policies
Reducing business costs (e.g., lower corporate taxes,
subsidies).
