Inflation | Business Studies Form 4

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Inflation - Business Studies Form 4

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INFLATION

Continuously increase in demand for goods and services in the economy without corresponding increase in supply will push prices up leading to inflation.


Introduction

Continuously increase in demand for goods and services in the economy without corresponding increase in supply will push prices up leading to inflation.



Types of inflation

Demand pull inflation

This is a type of inflation caused by excessive demand for goods and services without a corresponding increase in production resulting into rise in prices.

Causes of demand pull inflation

  • Increase in population.
  • Increase in government expenditure.
  • Printing and releasing of more currency which increases money in supply without corresponding increase in production.
  • A fall in the level of savings.
  • Expectation of future price increases.
  • Anticipation of future shortages of goods and services.

Cost push inflation

This is a type of inflation caused by increase in cost of factors of production which translates to increased prices of goods and services.

Causes of cost push inflation


  • Increase in wages and salaries.
  • Increase in cost of raw materials.
  • Increase in indirect taxes.
  • Increase in cost of energy, for example, price of oil.
  • Increase in cost of machinery and equipment used in production.

Imported inflation

This is a type of inflation which is caused by importation of high priced goods and services such as;technology/machines,skilled human resources and crude oil.

Causes of imported inflation

  • Importation of expensive technology especially highly skilled labour.
  • Importation of expensive machines and equipment.
  • Importation of high priced oil.

Levels of inflation

Mild inflation

This a slow rise in price level of not more than 5 % per annum. It is associated with low levels of unemployment and has beneficial effects on an economy. It shows a sign of buoyant economy or an expanding economy, implying generation of jobs, output and growth.

Hyper /rapid inflation

This is a very rapid accelerating inflation. It usually leads to breakdown of the country's monetary system as the currency may have to be withdrawn and a new one introduced.

Stagflation

This is an economic condition in which unemployment is high, the economy is stagnant, but prices are rising.

Galloping/runway

This is when prices are rising at double or triple digit rates of 20%, 100%, 200%.


Effects of inflation in an economy

Desirable effects

  • Mild inflation motivates people to work hard.
  • Mild inflation encourages proper utilization of resources.
  • Mild inflation increases investment and employment.
  • It promotes creativity in an economy.

Negative effects

  • Loss of money value.
  • Increased interest rates.
  • Leads to unemployment.
  • Discourages savings and investment.
  • Worsens balance of payments position.

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Controlling inflation

Fiscal measures:

  • Reducing government expenditure.
  • Increased tax on disposable income.
  • Government to subsidize production of goods and services.

Monetary policies
:


  • Increasing bank rates to discourage borrowing.
  • Selling government securities such as treasury bills and bonds.
  • Selective credit control.
  • Increase in cash or liquidity ratio.

Other measures:

  • Control population.
  • Curtail activities of trade unions.
  • Encourage domestic production.

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