INFLATION

Objectives:
At the end of the discussion, students should be able to;
1. Define inflation and distinguish it in present and future events;
2. Identify the different types of inflation;
3. Familiarize the sources and theories of inflation; and
4. Determine the price effect of inflation on the commodities and services in
economics.

Definition of Terms:
 Aggregate – total sum or combination of different elements.
 Purchasing power – ability of currency to buy goods and services.
 Offset – to balance out or counteract the effect of something.
 Stimulate – to encourage or prompt activity growth.
 Outpaces – to surpass or exceed the rate of something, typically in growth or speed.
 Self-reinforcing loop – A situation where a factor, often a behavior or condition leads to
a result that reinforces the original factor, creating a cycle of reinforcement.
 Real Income – Income adjusted for inflation, reflecting the purchasing power of an
individual or household’s earnings.

WHAT IS INFLATION?
Inflation is the rate of increase in prices for goods and services over a given period of
time. It is typically a broad measure, such as the overall increase in prices or the
increase in the cost of living in a country.

Inflation is the decline of purchasing power. It is measured by the average increase in

prices of goods and services over time.

CAUSES OF INFLATION
1. Money Supply
- A rapid increase in the money supply can lead to a rapid increase in inflation. This
happens when the money supply/circulation in a nation grows above the economic
growth, therefore reducing the value of the currency.

2. National Debt
- When a country’s debt increases, the respective country is left with two options: taxes
can be raised internally and additional money can be printed to pay off the debt. It can
 contribute to inflation by increasing the money supply, leading to higher demand for
goods and services and potentially pushing prices up.

3. Exchange Rates
- An economy with exposure to foreign market mostly functions on a basis of the dollar
value. In a trading global economy, exchange rates play an important factor in
determining the rate of inflation.

TYPES OF INFLATION

1. Demand - Pull Inflation

- A rise in the general level of prices caused by too high level of aggregate demand in
relation to aggregate supply. When all the productive resources are fully employed,
an additional demand for goods increases prices.

Example: When the housing market booms, demand for construction materials
spikes, leading to a higher price for goods like lumber.

2. Cost - Push Inflation

- A rise in the general level of prices that is caused by increased costs of making and
selling goods. Cost-push inflation does not result from pressures on demand.
Instead, the pressures are on the supply side.

Example: An increase in oil prices globally leads to a higher transportation costs,

which are passed on to consumers.

3. Built - In Inflation
- Occurs when workers demand higher wages to keep up with rising living costs. This
causes businesses to raise their prices in order to offset their rising wage costs,
leading to a self-reinforcing loop of wage and price increases.
EFFECTS OF INFLATION IN OUR ECONOMY
1. Decrease Purchasing Power
- As prices rise, the purchasing power of money decreases. This means that the same
amount of money buys fewer goods and services, leading to a decline in real income
for consumers.

2. Redistribution of Income and Wealth

 - Inflation can redistribute income and wealth within society. Debtors benefit from
inflation as they can repay loans with money that has lower purchasing power.
Conversely, creditors experience a decrease in the real value of the money they are
repaid.

3. Uncertainty and Reduced Consumer Confidence

- High or unpredictable inflation can create uncertainty about future prices, leading to
reduced consumer confidence and delaying purchasing decisions. Businesses may
also hesitate to invest or expand under uncertain economic conditions.

WHO BENEFITS FROM INFLATION?

Inflation helps people whose incomes rise faster than the rate of inflation. The following
are some people who can benefit from inflation.
1. Debtors
- They can benefit from inflation because the money they pay back at a later date
actually has a lower value than the money they borrowed.

2. Food and Agriculture Industry

- They can benefit from inflation through increased prices, leading to higher revenues
and profits. Additionally, inflation can stimulate demand for certain products and
services, driving sales growth in these sectors.

3. Land owners and real estate investors

- High inflation can devalue savings and liquid assets, but land maintains its worth,
often increasing in demand and price. Landlords tends to raise their rents during
inflation, potentially boosting their real income, especially with fixed mortgages on
rental properties.

WHO IS HURT BY INFLATION?

1. People on a fixed income
- People on a fixed income face challenges with inflation because their income
remains constant while the cost of goods and services rises. Their purchasing power
decreases over time, making it harder to afford the same standard of living.

Example: Retirees or individuals receiving pensions.

 2. Creditors
- Creditors may be hurt by inflation because it erodes the real value of the money
they are repaid, especially if loan interest rates do not adjust to account for inflation.
3. Savers
- The purchasing power of their savings diminishes over time. When inflation
outpaces the interest earned on savings, the real value of savings decreases.

MODERN INFLATION THEORY

The Philips Curve (Developed by the economist A.W. Philips.)

- A useful way of representing the process of inflation and for analyzing short-run
movements of unemployment and inflation.
- The Philips curve shows the inverse relationship between inflation and
unemployment. Higher inflation is associated with lower unemployment and vice
versa.

PRICE INDEX
- Inflation is usually measured by using price index.
- A price index is a number that compares prices in one year with some earlier base year.

DIFFERENT KINDS OF PRICE INDEX

1. Consumer Price Index (CPI)
- Measures prices for a basket of goods and services in the economy, including
food, cars, education, and recreation. It excludes things like savings, investments
and spending by foreign investor.
- The CPI is often the economic indicator of choice used for measuring inflation.
2. Producer Price Index (PPI)
- It reports the price changes that affect domestic producers.
- Tracks changes in the selling prices received by domestic producers for their
output.
- The PPI measures prices for fuel, farm products such as meats and grains,
chemical products and metals.
3. Wholesale Price Index (WPI)
- An index that measures and tracks the changes in price of goods in the stages
before the retail level.
- It is calculated for wholesale prices in which the quantities of the base year and
current year are different.
4. Export Price Index (XPI)
- Tracks changes in the prices of goods and services sold by domestic producers to
foreign buyers.
5. Import Price Index (MPI)
- Measures changes in the prices of goods and services purchased from foreign
sources by domestic buyers.