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Assignment 1
Subject:
Macro Economics
Submitted to:

Prof. Nabeela Asghar

Submitted By
GHULAM ABBAS
Roll Number 280
B.Com Hons 24/12/2010 3rd Semester
Section “D” Morning
Hailey College of Commerce
University of the Punjab

Lahore

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INFLATION
 What does Inflation mean?
 Definition of Inflation
 Causes of Inflation
 Effects of Inflation on an Economy
 Inflation Rate in Pakistan
 According to Pakistan Monetary and Fiscal Policy.
 Methods to Remove Inflation
 Conclusion

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What Does Inflation Mean?
The measure of price increases within a set of goods and
services over a period of time is known as inflation

Inflation can also be defined

as decrease in the value of money (or

loss of the purchasing power in some

medium of the commodity exchange).

In most simple words, we can conclude that inflation occurs

in an economy when the net demand for services and goods
exceeds the total supply. Now, because of less supply, the net
prices of these services/goods increases and this kind of situation
is known as inflation.

Definition of Inflation
We can define inflation as following;

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1-The rate at which the general level of prices for goods

and services is rising, and, subsequently, purchasing power is
falling

2-“Too much money chases too few goods.”

CAUSES OF INFLATION
Situation of inflation can occur at any time, and its
occurrence depends upon a number of reasons. No specific cause
is responsible for the occurrence of inflation. But some proposed
reasons of the inflation are mentioned below;

 Demand-pull inflation refers to the idea that the economy

actual demands more goods and services than available. This
shortage of supply enables sellers to raise prices until equilibrium
is put in place between supply and demand.
 
 The cost-push theory, this type suggests that shortages of
a certain good or product will affect the economy by raising prices

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through the supply chain from the producer to the consumer.

We can readily see this in oil markets. When OPEC reduces

oil supply, prices are artificially driven up and result in higher
prices at the pump.

 Money supply plays a large role in inflationary pressure as

well. Economists believe that if the Federal Reserve does not
control the money supply adequately, it may actually grow at a
rate faster than that of the output in the economy, or real GDP.
 Inflation can artificially be created through a circular increase
in wage earners demands and then the increase in producer costs
which will drive up the prices of their goods and services. As
demands go higher from each side, inflation will continue to rise.
 Increase In Cost of Production
If the production cost of various services and goods
increases then naturally the prices of the final products would also
increase. This leads into the situation of inflation.
 Price Power Inflation.
Inflation occurs when industries and business
houses increase the total prices of their services and goods in
order to amplify their profit margins. This category of inflation is
called as “administered price inflation” or “pricing power
inflation”.
This type of inflation is tedious to tackle because various
industries and business houses have the complete
authority/power of pricing their services and goods.
 A situation of inflation occurs when a specific section of a
mass industry increases the prices of its services and goods,

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because this step of a particular section of a mass industry will

produce considerable effects on various other sections of industry
also. For example- increase in the price of crude oil will
spontaneously cause increase in the train fares and airfares.
 Fiscal Inflation.
A special category of inflation known as “Fiscal
inflation” occurs, because of excessive spending of the
government. Fiscal inflation was first observed in United Sates of
America at the time of President Mr. Lyndon Baines Johnson.
 Hyper Inflation.
One another type of inflation is known as
hyperinflation. Hyperinflation occurs during or after a heavy war.
This inflation is also popular with the name of galloping inflation.
 Stagflation.
Another severe type of inflation is known as
stagflation. It occurs in an economy which faces economic
stagnation and high unemployment rate.

So we can say that inflation has some serious

consequences on the economy as a whole. So the government
should make some strict policies to curb inflation and thus help
the country to have a stable economy

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EFFECTS OF INFLATION ON AN
ECONOMY
Effects of Inflation on an economy can be in different
ways, which are as following:

 Effects on Debtors and Creditors:

When the currency depreciates, the creditors lose and the

debtors gain because the money borrowed when it was dear is
paid back when it is cheap.

If, For example, a person borrows Rs. 10,000 at a certain

time and repays the loan when prices in general have risen 50
percent, he gains a patent advantage. The sum of Rs.10, 000 which
he returns to his creditor will purchase only two-thirds as much as
it would have at the time the loan Rs. 15,000 to have the same
purchasing power.

 Effects on Wage-Earners and Salaried People:

The wage earning classes and salaried workers lose since

wages and salaries never increase. Wages and salaries do not
generally rise as high as the prices do. Therefore, the purchasing
power of wages and salaries diminishes during periods of rising

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prices, and the wage-earners and salaried workers are thus hard
hit.

 Effects on Importers and Exporters

It is a generally recognized principle. But not an entirely

unchallenged one, that exports will be easy and Imports decrease
if a country’s monetary unit depreciates under the pressure of
inflationary forces so that along with rising commodity prices at
home there is an even more rapid rise in the country’s foreign
exchange rates. Such stimulus to export trade is usually largely at
the expense of labor and of the producers of raw materials usually
do not advance as rapidly as does the rupee prices of the foreign
money.

The exporter gains by reason of this lag in price and

wage adjustments at home, but, as soon as the slack is taken up,
the exporter’s advantage disappears.

 Effects on Consumers

People as consumers also suffer heavily on account of the

rising prices. The cost of living rises proportionately to income;
savings are wiped out; and hard work and thrift seem to be false
goods.

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Under such conditions consumers are called upon to pay

higher prices for articles of

consumption.

Thus, Inflation gives rise to a

sense of futility and revolt among

the consumers.

 Effects on Agriculturists and Landlords;

The agriculturists as producers and as debtors gain by a

fall in the value of money. But landlords, on the other hand, suffer
temporarily because their income from rent is fixed.

But their case is a little peculiar in a country like

Pakistan, where the peasantry is in the firm grip of money –
lenders who pocket most of the profit according to the farmers on
the rent of which can easily be increased at the whims of the
landlords.

we have studied above that inflation is caused by the

failure of aggregate supply equal the increase in aggregate
demand. Inflation can, therefore, be controlled by reducing money

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income in order to control aggregate demand. Various methods are

usually grouped under three heads

Inflation Rate in Pakistan

We can see inflation rate in Pakistan according to this
table;

Trends in Growth and Inflation in Pakistan

Period GDP Growth Inflation Rate
Rate
1950—60 3.1 2.1
1960---70 6.8 3.2
1970---80 4.8 12.3
1980---90 6.5 7.8
1990---00 4.6 9.7
2001---09 5.2 8.4

Methods to Remove Inflation

We can divide methods to remove Inflation in to three parts.

1. Monetary measures
2. Fiscal measures

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3. Other measures

1.Monetary Measures
Monetary measures aim at reducing money incomes,

(a) Credit Control.

Any country adopts a number of methods to control the
quantity of money. For this propose, it raises the banks rates, sells
securities in the open markets, raises the reserve ratio, and adopts
a number of selective credit control measures, such as raising
margin requirements and regulating consumer credit.
Monetary policy may not be effective in controlling
inflation, if inflation is due to cost-push factors. Monetary policy
can only be helpful in controlling inflation due to demand-pull
factors.
(b) Demonetization of Currency;
However, one of the monetary measures is to
demonetize currency of higher denominations. Such a measure is
usually adopted when this is abundance of black money in the
country.
(c) Issue of New Currency.
The most extreme monetary measure is the issue of new
currency in place of the old currency. Under this system, one new
note is exchanged for number of notes of the old currency. The
value of bank deposits is also fixed.

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Such a measure is adopted when there is an excessive

issue of notes and there is hyper inflation in the country. It is very
effective measure, but is inequitable for its hurts the small
depositors the most.

2.Fiscal Measures
Monetary policy alone is incapable of controlling
inflation. It should, therefore, be supplemented by fiscal measures.
Fiscal measures are highly effective for controlling government
expenditure, personal consumption expenditure, and private and
public investment, the principal fiscal measures are the following;

(a) Reduction in Unnecessary Expenditure.

The government should reduce unnecessary expenditures
on non-development activities in order to control inflation.

(b) Increase in Taxes.

To control personal consumption expenditure, the rates
of personal, corporate and commodity taxes should be raised and
even new taxes should be levied, but the rates of taxes should not
be so high as to discourage saving, investment and production.

(c) Increase in Savings.

Another measure is to increase savings on the part of the
people. This will tend to reduce disposable income with the
people, and hence personal consumption and expenditure will
decrease. The government should float public loans carrying high
rates of interest, start saving schemes, or lottery for long periods,

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etc. all such measures to increase savings are likely to be effective

in controlling inflation.
(d) Surplus Budget.
An important measure is to adopt anti-inflationary
budgetary policy. For this purpose, the government should give up
deficit financing and instead have surplus budgets. It means
collecting more in revenues and spending less.
(e) Public Debt.
At the same time, it should stop repayment of public debt
and postpone it to some future date till inflationary pressures are
controlled within the economy. Instead, the government should
borrow more to reduce money supply with the public.
3.Other Measures

The other types of measures are those which aim at

increasing aggregate supply and reducing aggregate demand
directly.

(a) To Increase Production,

The following measures should be adopted to increase
production;
(i) One of the foremost measures to control inflation is to
increase the production of essential consumer goods
like food, clothing, kerosene oil, sugar, vegetable, oils,
etc.
(ii) If there is need raw materials for such products may be
imported on preferential basis to increase the
production of essential commodities.
(b) Rational Wage Policy.

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Another important measure is to adopt a rational wage.

Under hyperinflation, there is a wage price spiral. To control this,
the government should freeze wages, incomes, profits, dividends,
bonus, etc. but such a drastic measure only be adopted for a short
period.
(c) Price Control.
Price control and rationing is another measure of direct
control to check inflation. Price control means fixing an upper
limit for the prices of essential consumer goods. They are the
maximum prices fixed by law and anybody charging more than
these prices is punished by law. But it is difficult to administer
price control.

Conclusion.
From the various monetary, fiscal and other measures
discussed above, it be consider that to control inflation, the
government should adopt all measures simultaneously. Inflation is
like a hydra-headed monster which should be fought by using all
the weapons at the command of the government.

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