Inflation
1
Objectives of the chapter:
1- Introduction
2- Definition of inflation
3- Causes of inflation
4- Effects of inflation
5- Calculation of inflation
6- Deflation
7- Is inflation and deflation considered good for the economy of the country?
8- Who is benefited most by inflation and deflation?
Introduction
• Inflation happens when the price of goods and services increase, while deflation takes place when the price of the goods and
services decrease in the country. Inflation and deflation are the opposite sides of the same coin.
• Maintaining the balance between these two economic conditions, i.e. inflation and deflation is essential as the economy can
quickly swing from one condition to the other as a result of these two conditions. keeps an eye on the levels of price changes
and controls deflation or inflation by conducting monetary policy, such as setting interest rates.
1- Definition of Inflation
• Inflation is the rate at which the prices for goods and services increase. Inflation often affects the buying capacity of
consumers.
• Most Central banks try to limit inflation in order to keep their respective economies functioning efficiently. There are certain
advantages as well as disadvantages to inflation.
• Inflation refers to the increase in the prices of the goods and services of daily use, such as food, housing, clothing, transport,
recreation, consumer staples, etc.
2- Causes of Inflation
1- Money Supply
2- National Debt
3- Demand-Pull Effect
4- Cost-Push Effect
5- Exchange Rates
1- Money Supply
➢ Excess currency (money) supply in an economy is one of the primary cause of inflation. This happens when the money
supply/circulation in a nation grows above the economic growth, therefore reducing the value of the currency.
➢ In the modern era, countries have shifted from the traditional methods of valuing money with the amount of gold they
possessed. Modern methods of money valuation are determined by the amount of currency that is in circulation which is then
followed by the public’s perception of the value of that currency.
2- National Debt
➢ There are a number of factors that influence national debt, which include the nations borrowing and spending.
➢ In a situation where a country’s debt increases, the respective country is left with two options:
A- Taxes can be raised internally.
B- Additional money can be printed to pay off the debt.
3- Demand-Pull Effect
➢ The demand-pull effect states that in a growing economy as wages increase within an
economy, people will have more money to spend on goods and services.
➢ The increase in demand for goods and services will result in companies raising prices that the
consumers will bear in order to balance supply and demand.
4- Cost-Push Effect
➢ is an inflation that results from an initial increase in costs.
➢ There are two main sources of increased costs.
➢ An increase in the money wage rate
➢ An increase in the money price of raw materials, such as oil.
5- Exchange Rates
An economy with exposure to foreign markets mostly
functions on the basis of the dollar value.
In a trading global economy, exchange rates play an important
factor in determining the rate of inflation.
