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OTE2601 Assignment 2 2024
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OTE2601 Assignment 2 2024
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Name of module ECONOMICS MANAGEMENT SCIENCESModule code(s) OTE2601
ASSIGNMENT 2 QUESTIONS
QUESTION 1
Inflation is the word used to indicate a drop in the buying power of money as a result
of a general rise in prices of goods and services. In simple terms, inflation is an
increase in prices over a period of time. Inflation is what makes your money worth less
over time – it is your money’s biggest enemy. It reduces the buying power of money
month by month and year by year.
1.1 How does inflation affect the consumer? Elaborate on the most important
characteristics of inflation
(Study guide pg. 16)
Reduced Purchasing Power:
As prices rise, the same amount of money buys fewer goods and services.
Consumers find that their money doesn’t stretch as far, leading to a decrease in their
standard of living. For instance, if the price of groceries, fuel, and other essentials
increases, people may have to cut back on discretionary spending such as
entertainment or dining out.
Rising Cost of Living:
The overall cost of maintaining a certain standard of living increases as prices for
basic necessities like housing, food, and healthcare go up.
This can be particularly challenging for those on fixed incomes, such as retirees,
whose income does not increase at the same rate as inflation. They may struggle to
afford the same quality of life.
Wage-Price Spiral:
As prices rise, workers demand higher wages to keep up with the increased cost of
living. Employers then raise prices to cover the higher wage costs.
This creates a cycle of increasing wages and prices, which can perpetuate inflation.
Consumers may initially benefit from higher wages, but these gains are often offset
by higher prices.
Interest Rates and Borrowing Costs:
Central banks may raise interest rates to control inflation, making borrowing more
expensive.
, Higher interest rates increase the cost of loans for consumers, affecting mortgages,
car loans, and credit card debt. This can lead to reduced spending and investment,
as people prioritize paying off more expensive debt.
Savings and Investments:
Inflation erodes the real value of money over time, meaning that the purchasing
power of saved money decreases.
Consumers need to find investment options that at least keep up with inflation to
preserve their wealth. Traditional savings accounts may offer returns below the
inflation rate, effectively reducing the value of savings.
Uncertainty and Planning:
High or unpredictable inflation can make it difficult for consumers to plan for the
future.
People may delay significant financial decisions, such as buying a home or starting
a business, due to uncertainty about future costs and income. This can reduce
overall economic growth and stability.
Important Characteristics of Inflation
Optimism and Overconfidence:
During periods of inflation, there can be a sense of optimism driven by rising wages
and profits.
This can lead to overconfidence, increased borrowing, and speculative investments,
which may exacerbate inflation.
Increased Money Supply:
More money in circulation compared to the availability of goods and services.
An oversupply of money leads to higher demand, pushing prices up further.
Wage Demands and Price Increases:
Rising prices lead to demands for higher wages, which in turn lead to further price
increases.
This creates a feedback loop where inflation perpetuates itself through continuous
cycles of wage and price increases.
Monetary Implications:
Inflation causes a drop in the value of money.
Impact: This affects savings and long-term financial planning, as the real value of
money decreases over time.
Role of Expectations:
Expectations of future inflation can drive current behavior, such as spending quickly
before prices go up.
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