The Concept of Inflation - Essay Example

INFLATION The concept if inflation is indeed an important component considering how it influences many aspects of life. The paper seeks to delve into the causes of inflation in order to illuminate the factors which lead to the persistent increase in the prices. In the same way, it will provide an analysis into some of the effects of inflation while focusing on the different types of inflation arising from different economic situations. Introduction Inflation is described to be a rate in which the overall price of goods and services is increasing while the purchasing power decreases in an economy (Nicholson 57). Inflation usually causes money to lose its value. This comes about in that as inflation increases, currency only buys a small percentage of goods compared to what it used to when there was no inflation. This happens due to the increase in the money supply which is measured by the producer price index and the consumer price index over time. When inflation rises in an economy in higher rates, it leads to adverse effects in the economy. However, mild inflation in the economy can lead to positive effects such as creation of employment. To keep the rates of inflation low, monetary authorities usually central banks are given the responsibility of controlling prices. This paper will discuss various causes of inflation, types and the effects that it has in the economy. Causes of inflation One of the causes of inflation is cost-pushing. This is a case where companies incur a lot of costs in running their operations. Hall states that these higher costs are usually brought about by workers or trade unions pushing for their wage increase (163). When they receive the increase, the impact is felt by the consumer in that it transfers the cost to the consumer by increasing the costs of goods and services. This tendency is characterized by an increase in wages irrespective of the productivity. Productivity normally remains the same which leads to the increase in the prices of goods and services in order to counter the effect. When a lot of firms increase wages in the same manner and pass the effect to the consumer in terms of high prices, this the leads to inflation. Another cause of inflation is demand-pull. This is a case where the overall demand exceeds supply and is normally brought about when an economy experiences full employment. The demand can be in terms of goods and services or it can as well be the demand for labor. When the demand exceeds supply in the market, the suppliers have a tendency of increasing the prices of commodities. This is because of the surety that their goods will sell at whichever cost due to scarcity. If the supply of the goods remains low over a period of time, this leads to inflation because the prices will keep on getting higher and higher. This can also portray itself where employers demand more workers than what they can get. In turn, they increase their salary in order to attract more labor which leads to inflation in the long run. Exchange rate is another cause of inflation. This comes about when a nation has increased exposure to the foreign market. It is one of the critical factors that determine the rate of inflation. If the rate of exchange suffers, the local currency loses value to the foreign currency. This leads to the foreign goods becoming expensive to the local consumers which simultaneously lead to the local goods becoming cheap to the consumers in the overseas markets. In simple terms, the import price gets higher than the export price which leads to inflation. National debt is another cause of inflation. If a country has a higher debt, then this can accelerate the levels of inflation to higher rates. This leads to inflation because, if the debt increases, the government of the country is left with two options; to either print more money to pay off the debts or to increase the taxes which will lead to higher revenue hence provide means of settling the debt. Increase in tax is passed down to businesses that in turn increase prices of their products in order to offset the tax rate. Printing more money by the government causes high supply of money in the market which lead to devaluation of currency and increase in prices which in turn leads to inflation. Types of inflation There exist various types of inflation. One type of inflation is called galloping inflation. This type of inflation comes about due to the uncontrollability of mild inflation. This is inflation in the double digits or triple which occasionally ranges from 20-200% per year. This type of inflation was observed in most countries in Latin America like Brazil in the 1970s where the inflation rates were 50-700%. Creeping inflation: this type of inflation that is sometimes called mild or moderate inflation. There is a mild or gentle increase in the prices of goods in this kind of inflation. This comes about when the rate of inflation does not exceed 3 % each year. Hyperinflation: this is characterized by a higher rate of inflation where prices rise at an alarming rate. It is difficult to measure its magnitude because the price rate rises so fast. This type of inflation has adverse effects in the economy because the prices rise over a million percent in a year. It is characterized by higher prices that are uncontrollable even by the monetary authorities. Scarcity inflation is another type of inflation which is brought about by hoarding of goods. Hoarding is a situation where unscrupulous marketers or black marketers have an accumulation of excess basic commodities. Such people create an artificial shortage of the goods that are a necessity with an intention of selling them at higher prices. They do this especially when such goods are in shortage with an aim of getting higher profits from such goods. Another type of inflation is called stagflation. This is a situation where inflation and economic stagnation occur simultaneously and are left unchecked over a certain period of time. An example of this type of stagnation was witnessed in developed countries in 1970s when there was a dramatic increase in oil prices. Deflation: This is opposite of inflation. It is the sustained decline of goods and services . This is characterized by very low prices and higher rates of purchasing power. Effects of inflation One of the effects of inflation is that it reduces the value of money. With inflation, the value of money is reduced which comes about due to the increase in the prices of products. Money becomes less valuable, it can’t buy the same commodity that it could before inflation. This leads to one spending more to buy the same amount of goods. This has effect on the purchasing power of consumers in that it reduces it. This also affects the behavior of consumers where they tend to buy only the necessity. In general terms, the high prices discourage buying. According to Flemming, another effect of inflation is that it affects savings (191). This can portray itself in different ways. If the rate of interest is higher than the inflation rate, then the purchasing power grows though minimal due to the loss that inflation causes. However, if the inflation rate is higher than the interest, then the account loses its purchasing power. This discourages saving because there lacks the incentive of saving money. Inflation makes consumption to be more attractive than saving. Inflation also leads to the poor performance by stock markets. High inflation rates cause businesses to suffer financial loses if they don’t pass the increased costs down to the consumers. This in turn affects the value of the stock because it makes it to go down which then affects various people in relation to the business. It affects the person who had invested in the company stock making him/her suffer a financial loss. It also affects other people such as the company shareholders, the employees and the company itself. However, inflation does not only cause negative effective but it also has some few positives when controlled. It affects the government revenue in that with mild inflation come increased revenue. This is caused due to the higher tax revenues that the government has. This is considered positive because it improves the budget balance of the economy. It also slows the economy hence making it to be at a state of balance. Conclusion In conclusion, inflation in its broader sense can cause adverse effects but can also be a good tool of improving the economy if it is controlled. As observed, the effects of inflation can be either negative or positive. The effect it has usually depends on the rate at which it increases and whether it is able to be controlled or not. Works Cited Flemming, John Stanton. Inflation. London: Oxford University Press, 2003. Print. Hall, Robert Ernest. Inflation, causes and effects. Chicago: University of Chicago Press, 2010. Print. Nicholson, J. Shield. Inflation,. London: P.S. King & son, ltd., 2005. Print. Read More