Engineering Economics

Assignment No. 1

Inflation
What is Inflation?
 Inflation is defined as persistent upward movement in the general price level of goods
and services of daily use. Inflation results in a decline in purchasing power.
 According to most of the economists, inflation occurs when price increase average is
more than 5% per year for a sustained time.
Causes of Inflation:
1. Inflation can occur when prices rise due to increases in production costs, such as raw
materials and wages.
2. A surge in demand for products and services can cause inflation as consumers are willing
to pay more for the product.
Why is Inflation such a problem?
 The real problem is that not everything inflates at the same rate. If everything like
income, prices and house prices inflates at the same rate then everything is normal and
predictable. An alarming situation occurs when all things do not change at the same rate.
 Example: In 1941, in Hungry prices went high up to 150,000% a day. This became a
problem because other things like wages did not increase at such a high rate as prices of
daily use.

In the end, inflation reflects the instability of the world and the life itself.

Hyperinflation
What if Hyperinflation?
 Hyperinflation is very high, rapid, and continuous inflation. In a hyperinflation situation,
the prices of goods and services in an economy quickly rise to a level so high that they
become difficult to afford for most people.
 Hyperinflation tends to occur during a period of economic turmoil or depression.
 According to economist Michael K. Salemi states that hyperinflation as takes place when
the monthly inflation rate is greater than 50 percent.
 Example: At a monthly rate of 50 percent, an item that costs $1 on January 1 would cost
$130 on January 1 of the following year.
Causes of hyperinflation:

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 1. This is often caused by a government that prints more money than its nation’s GDP can
support.
2. Demand-pull inflation can also cause hyperinflation. Soaring prices cause people to
hoard, creating a rapid rise in demand chasing too few goods. The hoarding may create
shortages, aggravating the rate of inflation.

Case Study of Venezuela

The most recent example of hyperinflation is in Venezuela.
Prices rose 41% in 2013, and by 2018 inflation was at 80,000% according to Forbes. In 2017, the
government increased the money supply by 14%. Then they started promoting a new
cryptocurrency, the Petro, because bolivar lost almost all its value against the U.S. dollar. It
cannot afford the cost of printing new paper currency.
In response, people began using eggs as currency. Unemployment rose to over 20%, like the U.S.
rate during the Great Depression.

Cause of Hyperinflation in Venezuela:

Venezuela’s high inflation levels are due to the sum effect of
1. Relying too heavily on imports for basic goods.
2. Low Oil Prices –Venezuela economy is mainly based on selling oil as its main export. In
2014, oil prices plummeted, eroding revenues to the government-owned oil companies.
When the government ran out of cash, it started printing more.
3. High government spending – Former Chavez government implemented social programs
called Bolivarian Missions to improve living conditions for the poor which achieved a
high degree of success. They proved bad for the economy and because of the high
spending government failed to save money for future economic crises.
4. Government had instituted price controls for food and medicine. But mandated prices
were so low it forced domestic companies out of business. In response, the government
paid for imports.
5. Inefficient government industries, and governmental corruption.

How far did the crises go:

As of 2019, Venezuela’s foreign debt was about $100 billion. The annual inflation rate for
consumer prices was at 15,000% percent in early 2020. With the continued collapse of its
economy, the country is facing a monumental problem of debt repayment. At this moment, it is
the only country in the world suffering from true hyperinflation.

Solution of the Problem:

Beneath the current economic crisis is a political power struggle.

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1. Easiest method for fighting hyperinflation is dollarization. But due to the political power
struggle this option is not available to current President Maduro. Because opposition
leader is favored by United States so doing so would be seen as a sign of defeat for the
leader who has spent so much time denouncing the United States.
2. Encourage domestic trade to boost productivity and increase domestic demand instead of
centralizing power in state-owned enterprises.
3. Increase efforts on maintaining public order and establish government authority.
4. Cancel the price controls and too much social welfare.
5. Encourage free markets.
6. Develop potential profitable industries like tourism.

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