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Increase in prices - Essay Example

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A trend of rising prices or an increase in the general price level of an economy is known as inflation. It is also referred to as the sustained increase in the price level. The general perception is that inflation is a bad phenomenon and is detrimental to the growth of an economy…
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Increase in prices
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Increase in prices

Download file to see previous pages... However inflation cannot always be termed as "bad" if seen in terms of higher money incomes. The higher prices of everything would result in higher receipts for resource suppliers and hence a growth in their income levels.
Inflation usually results in the standard of living to decline because it now costs more to buy the same amount of goods and services. However there are some cases where the rising prices do not necessarily mean declining living standards. Following are some of the factors:
Nominal Income: If the economy is suffering from a period of rising prices and at the same time there is a commensurate rise in the level of income, this would not lead to a decline in living standards. This is because the increase in prices is offset by the proportionate increase in income, resulting in an unchanged consumption pattern. This is assuming everything else is constant.
Real income: This is the income that is adjusted for inflation. In cases where the nominal income is rising but the rate at which it is growing is less than the inflation rate, it would not lead to a boost in the standard of living. This is because the inflation will erode the purchasing power of money and people will be spending the extra income in the purchasing of the same amount of goods and services. ...
Since almost all countries are plagued by inflation, people look at their real income to determine their purchasing power rather than the nominal income.

Tax structure: In an economy where there is a favourable tax structure, the spending patterns are high. This is due to the fact that even though inflation is prevalent, people still have more of the disposable income left over after their regular purchases. The spending patterns have a multiplier effect and in turn lead a general boom in the economy. The excess spending means people are demanding more goods and services signalling to the producers to produce more. Since the level of production needs to be increased, producers would demand more labour and more production would thus lead to an increase in the national income of the country. To sum it up, tax breaks given to the people will not lead to a decline in the standard of living even in the presence of rising prices.

Labour: If the economy has more of the skilled labour as compared to the unskilled workforce and the labour productivity is high, this would also result in a higher standard of living. This is attributed to the fact that since the labour is skilled it would demand higher wages for each extra output it produces. Since the employers would want to retain the skilled labour, it would have to pay higher wages otherwise the labour would find jobs elsewhere. The higher wages would cause more spending and this would maintain or boost the standard of living even though the economy might be in the grips of inflation.

Interest rate: The level of interest rates in an economy is an important factor in determining the spending patterns of the consumers. If the interest rate is low, then borrowing is ...Download file to see next pagesRead More
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