Clear Concept Inflation

Clear Concept Inflation

Inflation

“A rise in the general level of prices”. The opposite of inflation is deflation which means a fall in the general level of prices.

 

Causes of Inflation

1.The Money Supply-the less currency there is in the money supply, the more valuable that currency will be ,to simplify it if more money will be available in market ,more buyers will be there hence more demand which leads to more price and high inflation

2. The National Debtas a country’s debt increases, the government has two options: they can either raise taxes or print more money to pay off the debt. A rise in taxes will cause businesses to react by raising their prices to offset the increased corporate tax rate. Alternatively, should the government choose the latter option, printing more money will lead directly to an increase in the money supply, which will in turn lead to the devaluation of the currency and increased prices

3. Demand-Pull Effect-people will have more money to spend on consumer goods This increase in liquidity and demand for consumer goods results in an increase in demand for products. As a result of the increased demand, companies will raise prices to the level the consumer will bear in order to balance supply and demand.

4. Cost-Push Effectwhen companies are faced with increased input costs like raw goods and materials or wages, they will preserve their profitability by passing this increased cost of production onto the consumer in the form of higher prices.

A simple example would be an increase in milk prices, which would undoubtedly drive up the price of a cappuccino at your local Starbucks since each cup of coffee is now more expensive for Starbucks to make.

5. Exchange Rates-When the exchange rate suffers such that the currency has become less valuable relative to foreign currency, this makes foreign commodities and goods more expensive to our consumers while simultaneously making our goods, services, and exports cheaper to consumers overseas.

 

TYPES OF INFLATION

  • Low Inflation-Such inflation is slow and on predictable lines which might be called small or gradual. It is sometimes also called ‘creeping inflation‘. For example monthly inflation that increases in single digits like 2.3%, 2.8%, 3.2%, 3.5% etc.
  • Galloping Inflation-This is very high inflation running in double or triple digits like 20%, 100% or 200% a year. Such kind of inflation was observed in certain Latin American countries like Argentina.
  • Hyper Inflation-This form of inflation is ‘large and accelerating‘ which might have annual rates in million or even trillion. In such inflation not only range of increase is very large but the increase takes place in a very short span of time and prices shoot up overnight.

EFFECTS OF INFLATION

  • On Creditors and Debtorsassuming that salaries would also increase due to price rise. This results in repaying the same amount of money with extra money at hand due to wage hike or increase in Dearness Allowance (DA for government employees).
  • On Investmentin the short run, higher the inflation lower is the cost of loan. Inflation increases the investment in an economy in the short run as it encourages producers to expand or increase production.
  • On SavingIn the short run, rising prices encourages people to deposit cash in hand with banks as money loses value so holding it does not much sense
  • On Exchange RateRising prices generally leads to depreciation of the currency which implies that the currency loses its exchange value in front of a foreign currency.
  • On ExportWith inflation, exportable items of an economy gain competitive prices in the world market. This boost a country’s exports.
  • On ImportsInflation gives an economy advantage of lower imports and import-substitution as foreign goods become costlier.
  • On WagesInflation increases the nominal or face value of the wages while its real value falls.

Is Inflation is Bad?

  • A healthy rate of inflation is considered to be approximately 2-3% per year.
  • A healthy rate of inflation is considered a positive because it results in increasing wages and corporate profitability and keeps capital flowing in a presumably growing economy
  • For example, if you wanted to buy a specific item, and knew that the price of it would rise by 2-3% in a year, you would be encouraged to buy it now. Thus, inflation can encourage consumption which can in turn further stimulate the economy and create more jobs

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