Inflation

Inflation is the sustain rise in price level , one of the main objectives of the macroeconomic performance is to keep low or stable inflation . There are two types of inflation, cost-push inflation and demand-pull inflation.

• Cost-push inflation caused by increases in cost of production leads to rise in price level.( A cost-push diagram can be presented here).

When the cost of raw material increases, the prices of the products are increased for producer to protect their profit.As well as when the wages of labour increased or indirect tax on goods or services increased which they pass to consumers, the price level tends to increased .

• Demand-pull inflation caused by the increases in AD ( AD shift to right)without any change in AS. A demand-pull inflation diagram can be drawn.)

When the economy is producing near the productive capacity, an increase in AD ( investment, government spending, consumer expenditure, net exports) will causes an increase in price level.For example, A fall in exchange rate, SPICED, imports expensive and export cheap, therefore, people will buy fewer imports while exports sells more, an injection to economy leads to multiplier effect(diagram) Or AD is increase more rapidly than AS( a positive output gap might be produced).

When inflation is high, unemployment is low, as supplier need to achieve high productivity to meet demands, so they might employ more workers.(Phillip's curve). However, nowadays high inflation might not reduce unemployment rate, it may because with the advanced technology supplier could use machines instead of workers.

The consequences of inflation

• Menu cost, the cost of changing price due to inflation
• A fall in value of money, each pound will buy less, the purchasing power of the money reduced.
• shoeleather cost, the extra time and effort involved in reducing money holdings.
• Administrative cost, to adjust account and negotiating with unions about wage rises.
• inflationary noise, the distortion of price signals caused by inflation, which means that the market price do not signal the relative scarcity of products value.
• random redistribution of income. inflation reduce the real interest rate( nominal interest rate - inflation rate), the borrowers gain more while lender will lose.
• lose of international competitiveness. when a country`s inflation rate is above its main competitors, the goods and services will be less competitive as more imports will be bought and less exports will be sold.
• uncertainty. people would be uncertain about how much they should spend and save, firms may be reluctant to invest.
• inflation cause inflation. The experience of inflation can lead people to behave in a way which causes inflation to continue.if people expect there will be an increasing inflation, they tend to buy more goods which rise the speed of inflation.
• Fiscal drag. people`s income dragged into a higher tax band as a result of tax brackets not being adjusted in the line with inflation.

The benefits of inflation:

Low and stable demand-pull inflation will cause economic to growth, since it bring a increase in real GDP, and firms are likely to invest to produce more output, thus unemployment rate can be reduced.

Cost-push inflation has more harmful effect to the economy than demand-pull inflation since it often accompanied with a fall in real GDP.

Deflation is the opposite of inflation, which is a fall in sustain price level. Whereas, reflation is a increase in aggregate demand only?????

Fiscal and Monetary policy (Demand-side policies) and supply-side policy are used by government to control inflation to be low and stable, thus to achieve economic growth.