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Inflation

Jodie O’Connor and Melissa Byrne

+Question 6

• (i) With reference to research you have completed discuss 3 main causes of inflation.

• Give 2 examples of economic history for each 1. Demand-Pull Inflation 2. Cost-Push Inflation 3. Increase in Money Supply

• (ii) Outline 3 problems of high inflation

+Overview

What is inflation?

How is it caused?

Problems with high inflation

Conclusion

References

+What is inflation?

It is the level at which prices for goods and services rise, and how buying power falls. It is best to have a steady growth of inflation as too much of a rise or too much deflation can be detrimental to the economy of that country. It is the central banks job to keep prices changes to a minimum. (Investopia, 2013)

Most central banks try to keep their inflation rates at 2-3%.

Irelands current inflation rate is 0.1% (Worldwide Inflation Data, 2013)

+Ireland’s inflation rate changes

+Inflation

For example in December 2012 a woman goes to do her Christmas food shopping when she arrives at the till her total was €200.

In December 2013 she bought the exact same things but it cost her €210. This means that in a year the trolley of shopping went up by 5% i.e. the inflation rate was 5%.

Here is a video that explains inflation in easy terms

+What causes Inflation?

There are 3 main causes of inflation

1. Demand-Pull Inflation

2. Cost-Push Inflation

3. Increase in Money Supply

AD = C + I + G + (X-M) where C is consumer

expenditure, I is investment, G is government

expenditure, X is exports and M is imports

+Demand-Pull Inflation

This happens when Aggregate Demand (AD) grows at a rate that is faster than Aggregate Supply (AS). (Bized)

Example : A company producing One Direction Clothing has a capacity to produce that is growing at 2%. Once the demand rate grows at the same rate or slower the company has no problem. When the One Direction concert comes around the demand soars up to 15%. We have “too much money, chasing too little goods”.

The solution for the company is to put up the price so that not everybody can afford it and demand will decrease.

+Demand-Pull Inflation

(Bized)

+Examples in History

In the US the increase in the value gold after the 2008 financial crisis caused demand pull inflation, this continued until gold reached an all-time high record of $1,895 per ounce on September 5, 2011.

Another example is the property boom in Ireland during the Celtic Tiger. House prices around the country soared to crazy prices but especially in the South Dublin costing way more than their value because everybody wanted houses in these ‘elite’ areas. Most of these peoples houses are in negative equity at the present time.

+Cost- Push Inflation

This happens when there is a rise in production costs. Such as wages or raw material costs.

There are fewer goods being produced by the company as it is more expensive to make the volume they were before the rise in production costs, therefore demand exceeds supply.

This causes the finished products price to increase causing inflation.

(Investopia, 2013)

+Examples in history

Natural disasters are a big cause of cost push inflation.

A tsunami and huge earthquake in 2011 in Japan caused this to happen. An estimated 28,000 were dead or missing.

Following this disaster Toyota, Nissan, Honda, Mitsubishi and Suzuki all had to suspend production which caused prices of car parts for these cars to skyrocket all over the world.

(Amedo, 2012)

+Examples in history

The formation of OPEC in the 1970s created a monopoly for this organisation. Before they formed together they didn’t think they were getting a fair price for their oil as it is a non-renewable resource.

The members of OPEC now produce 46% of oil each year and control 80% of the world’s known oil reserves. As long as the members stay to the price decisions of OPEC they can raise oil prices this creates cost-push inflation.

OPEC is blamed for aiding a 16 month recession in the US with the oil embargo. They quadrupled the price for a few months in 1973.

(Amedo, 2012)

+Increase in Money Supply

If a country prints too much money to get themselves out of recession which sounds like the easy way, the value of the money decreases in the ratio to the amount of money that is printed.

The more money you print the more inflation rises.

If too much money is printed it becomes worthless to the point where objects are exchanged for goods instead of money.

(S-cool, 2013)

+Examples in history

On 2nd December 2008 it was reported that in Zimbabwe the annual inflation rate was 516 Quintillion percent.

Mugabe thought to take the country out of recession he would just print more money.

Their money became worthless

The people started trading in gold.

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+Examples in History

In Hungary in 1946 hyperinflation occurred

Their inflation rate at its peak reached an outrageous of 13.6 quadrillion % per month. (13, 600, 000, 000, 000, 000%)

The largest denomination bill was a 100 Quintillion note. Prices ended up doubling every 15 hours.

+Problems with high Inflation

1. Money loses its value. The buying power of €100 in 2012 will not get you the same amount of goods in 2013.

2. There is an uncertainty of the value of money. It lessens the value of money and makes it difficult to predict what prices or wages will be in the future.

3. Changing menus or catalogues for company's. Prices rise with inflation so restaurants or places like Argos must get new menus or catalogues to use with higher prices.

4. As money loses its value, people start to use other things such a gold to buy things as their money become worthless. In Zimbabwe currently they have no currency because of the hyperinflation in 2008-2009. They use other countries currencies.

+Problems with high Inflation

5. Imports become cheaper than home produced goods. Our exports cant keep up with with the produce of other countries. This causes the Balance of Payments to fall apart which lead to exchange rates to fall.

6. Income is spent on objects rather than saving for example in the boom of the Celtic Tiger people were buying property for 4 times what it’s worth and is now in negative equity.

7. Extra resources are needed to accommodate the population with more money than they had before.

(Boundless)

+Conclusion

Inflation is the rise in prices and fall in buying power

The ideal inflation rate in 2-3%

3 mains types of inflation Demand-Pull Inflation Cost-Push Inflation Increase in money supply

+References

Amedo, K. (2012, 03 12). What is cost push inflation? Retrieved from US Economy: http://useconomy.about.com/od/inflationfaq/f/Cost-Push-Inflation.htm

Bized. (n.d.). Monetary Policy Inflation. Retrieved from Bized: http://www.bized.co.uk/virtual/bank/economics/mpol/inflation/causes/theories1.htm

Boundless. (n.d.). Measuring a nations output and income. Retrieved from Boundless.com: https://www.boundless.com/economics/measuring-a-nation-s-output-and-income/comparing-current-and-historical-values-with-inflation/introduction-to-inflation-and-its-consequences/

Investopia. (2013). Cost-Push Inflation. Retrieved from Investopia: http://www.investopedia.com/terms/c/costpushinflation.asp

Investopia. (2013). Inflation Definition . Retrieved from Investopia: http://www.investopedia.com/terms/i/inflation.asp

S-cool. (2013). A-level Economics Inflation and Monetary Policy. Retrieved from S-cool: http://www.s-cool.co.uk/a-level/economics/inflation-and-monetary-policy/revise-it/what-are-the-causes-of-inflation

Worldwide Inflation Data. (2013). Inflation Ireland - current irish infaltion rate. Retrieved from inflation.eu: http://www.inflation.eu/inflation-rates/ireland/inflation-ireland.aspx