Inflation and Deflation

CONTENT

1. Meaning, Types, Causes of Inflation
2. Effects and Controls
3. Deflation, Meaning and Causes
4. Effects and Controls
5. Terminologies Associated with Inflation

DEFINITION

Inflation- is a persistent rise in the general level of price of goods and services.  Inflation occurs when there is an increase in money supply without corresponding increase in volume of

production.

TYPES OF INFLATION

1.         Demand – Pull Inflation

2.         Cost – Push Inflation

3.         Hyper-Inflation

4.         Creeping Inflation

Demand – Pull Inflation – This occurs when there is excess demand for goods and services over the supply.  The factors responsible for this type of inflation may be due to population increase, increase in workers’ salaries and wages, etc.

Cost – push Inflation – Producers pay for factors of production, any slight increase in price of factor input will reflect in the price per unit.  For example: if there is an increase in price of flour, sugar, butter, automatically the price of bread would be high.

Hyper- Inflation – This occurs when the prices of goods and services are rising fast to

the extent that money is losing its value or its ability to buy goods.  War, budget deficits,

etc are the major causes of hyper inflation.  Hyper inflation is also known as – galloping

inflation or run away inflation.

Creeping Inflation – This type of inflation occurs when there is slow but steady rise in

the general prices of goods and services.  It is also known as persistent inflation

EVALUATION

1. What is inflation?
2.  Mention four types of inflation you know.

CAUSES OF INFLATION

1.         Inflation occurs when there is excess demand for goods and services e.g. demand pull inflation.

2.         Low productivity e.g. agriculture;

3.         Increase in salaries and wages.

4.         High cost of production.

5.         Budget deficit i.e. when government expenditure is more than its income.

6.         Inflation can also be caused if there is increase in population that will force demand to rise.

7.         Excessive bank lending.

8.         High cost of importing raw material can lead to high cost of goods.

9.         Hoarding – which is an act of creating artificial scarcity.

10.       Inflation can be caused due to industrial action by workers e.g. strike, tools down etc.

11.       Poor storage facilities.

12.       Money laundering – which is mass transfer and injection of money into circulation.

EFFECTS OF INFLATION

Inflation as a phenomenon is a necessary evil.  In other word, it has positive and negative

effects in the overall economy.

POSITIVE EFFECTS OF INFLATION

1.         During inflation, the debtor gains at the expense of the creditor.

2.         Inflation period serves as a period where businessmen make profit.

3.         Inflation stimulates investment.

4.         Employment rate is high during inflation.

5.         Due to the second, third and fourth points stated above, inflation helps the economy to grow.

Negative effects of inflation

1.         The lenders (creditors) incur loss because the money loses its value as inflation persists.

2.         Distortion in the economy due to agitation for increase in wages and salaries.

3.         Fixed income earners e.g. salary earners suffer a lot during inflation.

4.         Money loses its value during inflation.

5.         It leads to balance of payment problems.

6.         Inflation discourages savings since money loses its value day in day out.

7.         Fall in living standard of the people.

EVALUATION

1.        State four positive effects of inflation.

2.         State five causes of inflation

HOW TO CONTROL INFLATION

1.         In an attempt to stem inflation, the government should encourage industrialization to make goods and services available.

2.         Where inflation is triggered by increase in money supply, effective interest rate could be adopted i.e. increasing the interest rate to discourage excess borrowing.

3.         Effective use of fiscal policy e.g. Taxation as a way of reducing the disposable income of workers can help to check inflation.

4.         Removal of bottlenecks in the distribution system.  This will enhance free flow of goods.

5.         Legislation could be put in place to check the activities of hoarders.

6.         Contractionary monetary policy can also help to check inflation where inflation is caused by increase in money supply.

7.         Subsidies – for farmers, business, will help in solving the problem of increase in the prices of inputs e.g. hoe, cutlass.

8.         Wage freezing i.e. government should not increase salaries.

EVALUATION

1.         Describe the effects of inflation on the economy of a country.

2.         What efforts has the government of Nigeria made to combat inflation?

TERMINOLOGIES ASSOCIATED WITH INFLATION

1.         INFLATION GAP – This is an economic situation in which the total demand in the economy exceeds the total supply of goods and services available to satisfy demand.  To arrive at this, subtract the total amount of money available for spending from the total money value of the actual good and services available to meet the demand.

2.         INFLATION SPIRAL – An increase in price will make workers to demand for an increase income (wages and salaries).  This will cause a rise in general level of price.  This is known as inflation spiral.

3.         DISINFLATION – The direct control of consumer’s expenditure as a way of checking inflation is known as disinflation.  This is done by reducing the supply of money and increasing interest rates etc.

4.         REFLATION – This refers to economic state of affairs in which prices, employment, output etc. is picking up again as a result of conscious government policy to that effect.

5.         STAGFLATION – When high rate of inflation exists at the same time as industrial production is slowing down, then we refer to this as stagflation.

6.         SLUMPFLATION: Slumpflation occurs when economic condition in which much reduced economic activity co-exists with inflation.

DEFLATION– is defined as a persistent fall in the general level of price. This is a

situation where the volume of money in circulation is not sufficient to meet up with the

prevalent economic situation. This is a direct opposite of inflation.  This is a fall in

general level of price as a result of decrease in the volume of money in circulation.

CAUSES OF DEFLATION

1.         Deflation is caused by failure of government to spend i.e. Budget surplus.

2.         When banks increase their interest rate, it discourages borrowing as such money supply drops.  This amounts to deflation.

3.         Where the productivity exceeds the demand coupled with decrease in money supply then deflation sets in.

4.         Where workers are excessively taxed leaving them with little disposable income, their marginal propensity to consume drops thereby leading to deflation.

EVALUATION

1.         Write a short note on; (a) inflation gap (b) stagflation (c) deflation

2.         State four causes of deflation.

READING ASSIGNMENT

Amplified and Simplified Economics for SSS by Femi Longe page 196-204

GENERAL EVALUATION QUESTIONS

1. Define the term limited liability.
   1. Explain the term external economies of scale
   1. Outline any four features of scale a firm enjoys as it grows in size.
   1. Distinguish between a cheque and a bank note.
   1. What is public recurrent expenditure?

WEEKEND ASSIGNMENT

1.         An inflation in which the price level rises steadily at an average rate of about 2% per annum is best described as (a) galloping (b) induced           (c) creeping (d) suppressed (e) run-away

2.         Inflation in any economy_____ (a) has no monetary connection (b) implies a sustained decrease in the general price (c) always increase the value of the national currency

            (d) tends to redistribute income (e) tends to bring down market prices

3.         Which of the following statements is not true in an inflation period. (a) the purchasing power of money diminishes     (b) wages rise simultaneously with price (c) more money runs after a limited quantity of goods    (d) fixed income earners lose    (e) aggregate real demand exceeds aggregate real supply.

4.         Inflation caused by an increase in demand is known as ___________

            (a) cost – push inflation               (b) hyper-inflation     (c) demand- pull inflation

(d) creeping inflation    (e) runaway inflation

5.         One way to solve the economic problem of inflation in a country is by increasing the (a) supply of commodities   (b) supply of currency (c) salaries of workers

            (d) demand for commodities

THEORY

1.         What is inflation? Discuss four ways of combating inflation.

2.         State three positive effects and two negative effects of inflation.