inflation

what is inflation?

my simplest definition Inflation is an increase of price of goods and services.

another definition inflation is the persistent rise in the general level of prices. As the general level of price rises each unit of money buys less quantities of goods and services. It reduces the purchasing power of money. the fall in the value of money is also known as depreciation

some of the economists believe that inflation is beneficial in some cases and benefited by some of the economic sectors for example debtors.

On the other hand inflation is a virus to the economy of a country and a whole world because inflation weakens the value of money, lower the living standard and eventually people lose confident to use the country’s currency.

In some cases inflation may set in gradually leading to a moderate persistent increase in price level, this form of inflation is known as Creeping inflation. in a situation where there is persistent price increase it results to another form of inflation known as Galloping inflation. If galloping inflation persists without control it may develop to hyperinflation which may lead to the collapse of the currency.

Types of inflation

  1. Demand-pull inflation: This is the increase of price of goods and services due to excessive demand of goods and services without corresponding increase in production.
  2. Cost-push inflation: cost-push inflation is an inflation caused by increase in cost of production such as cost of raw materials, cost of labor (wages and salaries), rent, indirect tax and other costs of production.
  3. Imported inflation: countries which depends on imported goods and inputs from other countries are likely to acquire such goods at high prices. the effect of this influences price level leading inflation.

Causes of inflation

  1. Consumers increasing their expenditure
  2. Increasing in government spending
  3. Increase in exports or fall in imports
  4. Autonomous rise in money supply or a fall in demand for money
  5. Increase in wages and salaries
  6. Increase in population
  7. Increase in factors of production
  8. Increase in indirect cost

effects of inflation in an economy

inflation has both positive and negative effects in an economy

Positive effects of inflation

  • Motivation of hard work
  • Increase in productivity
  • Utilization of resources
  • Increased investment and employment

negative effects of inflation

  • Inflation weakens the value of the local currency
  • Decline in standard of living for people earning fixed income
  • Lenders loose to borrowers
  • Inflation discourages saving
  • Balance of payment deficit
  • Increased cost in implementing of development plans

Controls of inflation

  1. Monetary policy: This is a policy implemented by the monetary authority in a country (Central Bank) and is concerned with the controlling of economic activities of the country. this carried out through various tools and these tools include
    • Bank rate
    • Open market operation
    • selective credit control
    • reserve requirement
  2. Fiscal policy: This is a policy that deals with government expenditure and government revenue (Taxation) to influence consumption and production. Increasing direct tax reduces people’s disposable income, Disposable income is the income that is left to individuals and households after paying tax. therefore reducing their consumption expenditure which in turn reduce inflation. On the other hand reduced government expenditure is a way of reducing the amount of money in circulation which in turn reduce inflation.
  3. price control: government fixes the highest price (price ceiling) and the lowest price (price flooring) of goods and services.
  4. Increasing imports: increasing imports leads to increased volume of goods and services. the increased volume of goods reduces the excessive demand of goods and services.

Consumer price index (CPI)

Consumer price index also known as retail price index (RPI) is the number that indicates the price of a same commodity at two different periods. It is a comparison between the current period price and the base year price of the same commodity.

Consumer Price index is calculated as current period price of the basket divided by base year period price of the basket and then the fraction is multiplied by 100.

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