Inflation (1)

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INFLATION

• By Prescious Ann Joy Eleuterio
• Lauren Julleza
• Nicole Aira Bilbao

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• In economics, inflation is a sustained increase
  in the general price level of goods and services
  in an economy over a period of time. When the
  price level rises, each unit of currency buys
  fewer goods and services.

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• Inflation is defined as a sustained increase in
  the general level of prices for goods and
  services. It is measured as an annual percentage
  increase. As inflation rises, every peso you own
  buys a smaller percentage of a good or service. 
• (Investopedia,2013)

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CAUSES OF INFLATION
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• Inflation means there is a sustained increase in
  the price level. The main causes of inflation are
  either excess aggregate demand (economic growth
  too fast) or cost push factors (supply side
  factors)

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 Demand Pull Inflation

• If the economy is at or close to full employment
  then an increase in AD leads to an increase in
  the price level. As firms reach full capacity,
  they respond by putting up prices, leading to
  inflation. Also, near full employment, workers
  can get higher wages which increases their
  spending power

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 Cost Push Inflation

• If there is an increase in the costs of firms,
  then firms will pass this on to consumers. There
  will be a shift to the left in the AS.

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Cost push inflation can be caused by many factors
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 Rising Wages

• If trades unions can present a common front then
  they can bargain for higher wages. Rising wages
  are a key cause of cost push inflation because
  wages are the most significant cost for many
  firms. (higher wages may also contribute to
  rising demand)

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Import Prices

• If there is a devaluation then import prices
  will become more expensive leading to an increase
  in inflation. A devaluation / depreciation means
  the Peso is worth less, therefore we have to pay
  more to buy the same imported goods.

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Raw Material Prices

• The best example is the price of oil, if the oil
  price increase by 20 then this will have a
  significant impact on most goods in the economy
  and this will lead to cost push inflation.

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Profit Push Inflation

• When firms push up prices to get higher rates of
  inflation. This is more likely to occur during
  strong economic growth.

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Declining productivity

• If firms become less productive and allow costs
  to rise, this invariably leads to higher prices.

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Higher taxes

• If the government put up taxes, such as VAT and
  Excise duty, this will lead to higher prices, and
  therefore CPI will increase. However, these tax
  rises are likely to be one-off increases. There
  is even a measure of inflation (CPI-CT) which
  ignores the effect of temporary tax
  rises/decreases.

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Effects of Inflation
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Effects on Redistribution of Income and Wealth

• Debtors and Creditors
• During periods of rising prices, debtors gain
  and creditors lose.

I would like to borrow 100.00 please Mr. Crabs,
to buy Gary a new bed
Ok, I will lend you 100.00 but in one year you
must pay back 6 interest
meow
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Meanwhile

• Who will be
  better off in a years time,
• Mr. Crabs or
• SpongeBob?

Prices in bikini bottom are rising at 10!
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Heres your 106.00 Mr. Crabs
But. Prices have rose by 10, if I wanted to buy
a new cash register a year ago I would only have
to pay 100.00, now I have to pay 110
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Effects on Redistribution of Income and Wealth

• Salaried Persons
• Salaried workers such as clerks,
• teachers, and other white collar persons lose
• when there is inflation. The reason is that
• their salaries are slow to adjust when prices
• are rising.
• Equity Holders or Investors
• Persons who hold shares or stocks of companies
  gain during inflation. For when prices are
  rising, business activities expand which increase
  profits of companies. As profits increase,
  dividends on equities also increase at a faster
  rate than prices. But those who invest in
  debentures, securities, bonds, etc. which carry a
  fixed interest rate lose during inflation because
  they receive a fixed sum while the purchasing
  power is falling.

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Effects on Redistribution of Income and Wealth

• Businessmen
• Businessmen of all types, such as producers,
• traders and real estate holders gain during
  periods
• of rising prices. Take producers first. When
  prices
• are rising, the value of their inventories rise
  in the
• same proportion. So they profit more when they
• sell their stored commodities.
• Fixed Income Group
• The recipients of transfer payments such as
  pensions, unemployment insurance, social
  security, etc. and recipients of interest and
  rent live on fixed incomes. Pensioners get fixed
  pensions. Similarly the renter class consisting
  of interest and rent receivers get fixed
  payments.

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Effects on Redistribution of Income and Wealth

• Government
• The government as a debtor gains at the expense
  of households who are its principal creditors.
  This is because interest rates on government
  bonds are fixed and are not raised to offset
  expected rise in prices. The government, in turn,
  levies less taxes to service and retire its debt.

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Effects on Production

• Misallocation of Resources
• Inflation causes misallocation of resources
  when producers divert resources from the
  production of essential to non-essential goods
  from which they expect higher profits.
• Reduction in Production
• Inflation adversely affects the volume of
  production because the expectation of rising
  prices along-with rising costs of inputs bring
  uncertainty. This reduces production.

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Effects on Production

• Fall in Quality
• Continuous rise in prices creates a
• sellers market. In such a situation, producers
• produce and sell sub-standard commodities
• in order to earn higher profits. They also
• indulge in adulteration of commodities.
• Reduction in Saving
• When prices rise rapidly, the propensity to
  save declines because more money is needed to buy
  goods and services than before. Reduced saving
  adversely affects investment and capital
  formation. As a result, production is hindered.

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Effects on Production

• Government
• Inflation affects the government in various
  ways. It helps the government in financing its
  activities through inflationary finance. As the
  money incomes of the people increase, government
  collects that in the form of taxes on incomes and
  commodities. So the revenues of the government
  increase during rising prices.

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Other Effects

• Net Exports
• When prices rise more rapidly in the
• home country than in foreign countries,
• domestic products become costlier
• compared to foreign products.
• Encourages Speculation
• Rapidly rising prices create uncertainty among
  producers who indulge in speculative activities
  in order to make quick profits. Instead of
  engaging themselves in productive activities,
  they speculate in various types of raw materials
  required in production.

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Other Effects

• Unemployment
•  When the cost of goods and services
• go up, companies have higher overhead costs
• and consumers purchase less. This can lead
• to a downturn in the economy where jobs are
• the first casualty.
• Political
• Rising prices also encourage agitations
• and protests by political parties opposed
  to
• the government. And if they gather momentum
  and become unhandy they may bring the downfall of
  the government. Many governments have been
  sacrificed at the altar of inflation.

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SOLUTIONS to
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The government can help reduce inflation by
applying the following policies

• Fiscal Policy
• Monetary Policy
• Supply side Economic Policy
• Direct Control Policy

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Fiscal Policy

•  is the means by which a government adjusts
  its spending levels and tax rates to monitor and
  influence a nation's economy. It is the sister
  strategy to monetary policy through which a
  central bank influences a nation's money supply.

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Monetary Policy

• involves altering base interest rates, which
  ultimately determine all other interest rates in
  the economy, or altering the quantity of money in
  the economy. Many economists argue that altering
  exchange rates is a form of monetary policy,
  given that interest rates and exchange rates are
  closely related.

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Supply Side Economic Policies

• seek to increase productivity, competition and
  innovation  all of which can maintain lower
  prices. These are ways of controlling inflation
  in the medium term.
• A reduction in company taxes to encourage greater
  investment.
• A reduction in taxes which increases risk-taking
  and incentives to work a cut in income taxes
  can be considered both a fiscal and a supply-side
  policy.
• Policies to open a market to more competition to
  increase supply and lower prices.
• Rising productivity will cause an outward shift
  of aggregate supply.

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Direct controls 

• a control that is directly imposed upon the
  manufacturing, pricing, and distribution of
  specific goods in contrast with an indirect or
  general control (such as a credit and fiscal
  policy) that affects the economy in its entirety
  and specific goods only indirectly

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Philippine Inflation Rate for 2015
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Source Philippine Statistic Authority