Economics Assignment on Inflation
Added on 2020-05-01
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Running head: ECONOMICS ASSIGNMENTEconomics AssignmentName of the Student:Name of the University:Author note:
1ECONOMICS ASSIGNMENT1.0IntroductionInflation is defined as the rise in the general level of the prices for the goods and serviceswithin a country over a period of time. According to Mankiw (2014), inflation represents the fallin the value of the currency. When the general price level rises, each currency unit purchasesfewer amounts of goods and services. Hence, inflation represents a decline in the purchasingpower of each unit of money. This is a loss in terms of real value of goods and services, and inthe medium of exchange i.e. money. Thus, inflation makes people to spend more money for thesame unit of goods due to higher price or get lesser amount of goods at the cost of same unit ofmoney over time (Linde 2017). This way inflation raises the cost of living within a country. Asinflation reduces the purchasing power of the currency, its value depreciates. The general level ofprices for a given time is obtained through the creation of a price index. Price index is a weightedaverage for a basket of commodities or services for a given period of time in a given region. Theprice index is a statistic, which helps in comparing the changes in the price level for thiscommodity basket over a given period of time. The most common index used to measure theinflation of a country is the Consumer Price Index (CPI) (Galí 2015). Inflation is measured by the rate of inflation. This is the percentage change in the priceindex of the commodities and services in a country, measured annually (Sargent 2013). Thispercentage helps in assessing the speed and value of the rise and/or fall in the value of currency.For example, if the rate of inflation is 1.5% for a certain commodity, say a gallon of gas, then theprice for one gallon of gas will rise by 1.5% in the next year. The percentage change in the CPI isused as the measure of inflation in a country. All the monetary factors, such as, wages, pensions,salaries, etc. and the prices of commodities and services are indexed to get the real value of those
2ECONOMICS ASSIGNMENTand this gives the rate of inflation of a country. There are other indexes also, such as, whole saleprice index, cost of living index and GDP deflator. 1.1 Types of inflation and the reasonsThere are different types and reasons for inflation. According to Arrow and Kruz (2013),inflation if two types; demand pull and cost push. Demand pull inflation occurs from the demandside while cost push inflation occurs from the supply side. When the economy grows at a veryfaster rate, people have more money to spend and demand for commodities and services rises ata very fast pace. This creates excess demand in the market and pushes the price level to go up.This is known as demand pull inflation (Roux and Hofstetter 2014). On the other hand, when thecost of production increases due to the price rise of the factors of production, the producers try tomake profit by raising the prices of the products. This is known as the cost push inflation(Mankiw 2014). If the prices for energy and raw materials increase, the price for the finalproduction increases, resulting in cost push inflation.
3ECONOMICS ASSIGNMENTASAS2AS1ADAD1AD2P1P2P2P1PricePriceReal GDPReal GDPY1Y2Y2Y1Demand pull inflationCost push inflationFigure 1: Demand pull and Cost push inflation(Source: Author)According to the above diagram, in case of demand pull inflation, the aggregate demandcurve shifts rightward creating excess demand in the market and pushes the price up. On theother hand, in case of cost push inflation, the aggregate supply curve shifts upward and thesupply is reduced in the market. Scarcity of goods pushes the price up causing cost push inflation(Sargent 2013). Other than these two types, there are expected and unexpected inflation and wage pullinflation. Sometimes the increasing wages create inflation in an economy. It is usually a
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