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Inflation - Essay Example

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Macro & Micro economics: Inflation Introduction Inflation is the state of an economy when the general price level in the economy rises due to the falling value of money. This term involves a wide range of variables and does not have any fixed satisfactory definition…
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Inflation

Download file to see previous pages... Inflation defined in this way refers to monetary inflation, which is the difference between the growth in money supply and the growth in availability of goods and services in the economy (Siegl, 2009). There are various measures of inflation, but most commonly, inflation is measured by using Consumer Price Index (CPI). The CPI refers to price of a basket of commodities and services that an average customer buys and changes in this index allows economists to study the rise and fall of the general price level in the economy which helps them to study the rate of inflation in the economy. In the latter half of 2012, Bank of England Chief Economist, Spencer Dale, had warned that the average standard of living for the Britons would fall in 2013. The country (UK) is still on the recovery phase from the shock of the financial crisis, this process is a slow and painful one. With a high unemployment rate of 7.8% and wage growth struggling to keep up with inflation, 2013 is looking to be another year of hardship. Causes of inflationary pressure Inflation refers to the upwards movement of the general price level in economy. Prices are determined in the free market economy through the interaction of the sellers and the buyers in the economy. Most economists consider that the inflationary pressure in the economy is caused from either the demand side (demand pull inflation) or the supply side (cost push inflation) pressure on the equilibrium condition in the market (P. J. Welch and G. F. Welch, 2009). Demand pull inflation In long run, when the total output in economy moves towards the full employment output, the economy operates nearly at the full capacity. At full capacity, the economy produces the maximum amount of output by utilizing the available factors of production and the production level cannot be expanded easily. Figure 1: Demand Pull inflation (Source: Pettinger, 2013) At the other end, consumers in the economy are themselves the workers and they are earning more since output level is high at this stage. Hence, there is high consumer demand for services and commodities. This demand pressure from households coupled with the near full capacity production by the producers in the economy triggers inflationary pressure in the economy (P. J. Welch and G. F. Welch, 2009). Cost push inflation Inflationary pressure also occurs when cost to sellers of goods and services rise. Any source of cost to businesses is also a source of increase in rise in prices. Cost to producers and sellers are transferred to buyers partially or wholly and they through rise in prices. Figure 2: Demand Pull inflation (Source: P. J. Welch and G. F. Welch, 2009) Upwards pressure is created on prices if costs of labour, fuel, raw materials and other factors of production rise. At times firms’ attempt to enhance profit in certain industries increases prices and creates inflationary pressure (P. J. Welch and G. F. Welch, 2009). Inflation in UK Between 1989 till present (2013), inflation rate in the UK averages at 2.81%. In May 2013, the inflation rate was 2.70% (Trading Economics, 2013). The inflation rates between 2011 and 2013 is shown in the following figure. Figure 3: Inflation rates in UK 2011-2013 (Source: Trading Economics, 2013) Demand side policies to combat inflation The most important tool to control inflationary pressure in the UK has been monetary policy changes. In the UK, the Bank of England adopts a monetary policy that helps ...Download file to see next pagesRead More
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