Exam (elaborations)
Inflation
- Institution
- University Of Cape Town (UCT)
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Contemporary economic issues: InflationCharacteristics of inflation
Inflation is a process:
Inflation is a sustained increase in the general price level over an extended period of
time.
Inflation doesn’t mean a price increase of a few products.
It’s also not a seasonal change in a few items.
If there is a general rise in prices of many products it effects the general price level
Transport plays a role in cost of almost all products
Inflation is an economic problem:
Dealing with inflation is part of the monetary policy of the SARB
Inflation is linked to purchasing power:
Inflation is strongly linked to the real value of money
The real value of money is the amount of g/s that can be bought with a certain amount
of money
It’s not the amount people earn but what that money can actually buy.
Inflation leads to demands for higher wages:
Rising prices lead to workers demanding increased wages. When wages are granted
CoP increases = firms increase their prices to maintain profits.
Inflation rate fluctuates from time to time:
Rate at which inflation increases isn’t constant , it increases very fast and very slowly
from time to time
An increasing rate of inflation is experienced when prices increase at a faster rate than
before
Disinflation is a decreasing rate of inflation where prices continue to increase but at a
slower rate than before
Inflation rates differ between countries:
Developed countries = lower rates of inflation i.e. 1-3%
Developing countries = higher rates of inflation i.e. 20%
Measurement of inflation
Basket of goods and services:
Inflation is measured by a basket of g/s bought by the average consumer
The cost of that basket over 12months can figure out CPI
CPI represents the average price of g/s bought by SAs each month
Base year:
Base year is the year which the changes in the value of a variable are measured
Calculating CPI:
CPI= (price of basket in current year) / (price of sane basket in the base year) * 100
When inflation rates are calculated for a calendar year, the average inflation rate from
all the months in 1 year are compared to another years average
Current prices means nominal prices(prices at current year)
Constant prices means real prices ( prices with the effects of inflation removed)
Inflation targeting
Is an economic policy where the SARB sets a preferable rate of inflation and attempts
to reach it
SARB set a rate in-between 3%-6% and uses CPIX rate
The advantage of this policy is that the public and markets know what the central bank
is trying to achieve
, Business can plan
SARB expects this to keep wage demands and price increases under control
Types of inflation:
Inflation can be classified as consumer/producer inflation:
Consumer inflation:
Headline inflation – takes into account price changes in all g/s in the basket measured
by the CPI
Core inflation – CPI excluding goods from the CPI basket (because their prices change
frequently) i.e. fresh/frozen meat , fish , fruit
CPIX is the CPI excluding repayments on mortgage bonds
Producer inflation:
Measured by the producer price index (PPI) – measures changes in prices of
manufactured goods before these goods are sold to consumers – measured before price
changes have had the chance to filter to houses – PPI useful to predict change in the
CPI and CPIX inflation rates
Stagflation – ongoing high inflation combined with high unemployment , low growth in
the GDP and stagnant demand in the economy
Deflation – prices of a wide range of g/s decrease continuously over an extended period
– opposite to inflation and can discourage investment
Hyperinflation – rate of inflation is over 50% - associated with political or social conflict
Causes and consequences of inflation
Monetary reasons:
When interest rates are low = consumers borrow more = money supply increases =
inflation.
SARB controls this by increasing repo rate = interest rates go up = discourages
demand
Demand-pull inflation:
Occurs when demand by consumers is growing faster than supply = increased prices
Usually occurs in growing economies
When demand increases but production remains the same
Excess demand = prices being pulled up
Demand-pull caused by combination of:
Increased household spending(demand)
More credit available
Increase gov. spending
Greater income from exports
As long as consumers are able to borrow they are able to increase demand for output
Too much money chasing too few goods
Cost-push inflation:
Occurs when there is an increase in the CoP
Increased costs push up price level
When costs go up , they need to increases prices to maintain profit
Main causes are:
Wage increases – main source of inflation
Increased profits – profit margins increase – firms use market power to raise
prices
Natural disasters – floods , fires, droughts cause food prices to go up
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