inflation 2

7/28/2019 Inflation 2

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http://www.youtube.com/watch?v=2PVwzSEUjiI


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INFLATION:

SUSTAINED RISE IN GENERAL

PRICE LEVELtoo much money chasing too

few goods

Shortage ~cause P


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INFLATION BUBBLE


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Purchasing powerthe amount of goods and services that can be

purchased with a given amount of money.

P , Purchasing power

P , Purchasing power


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Real GDP

The actual/ real total output in the economy ( totalamount of g & s).

Nominal GDP

Includes inflationary effect in GDP.

GDP measured using current price level.

Real GDP = Nominal GDP - Inflation


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The Keynesian model

show changes inAE, and how it brings about changes in the

levels ofproduction, income, employmentandprices.


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The AD and AS model

used to illustrate the effect of changes in both AD and AS, onthe levels ofoutput (GDP), income, employment and prices.


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P expensive DD O Y Real GDP

P ; Real GDP P ; Real GDP


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AD curve

AD

YY1

P

P1

Price level

(P)

Real GDP/ Realincome

0

~Downward slopping

~AD Changes due tochanges in the general

level of price

~does not shift

~move along the curve


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Price level (P)

AD1

Real Output0

AD2AD3

Real Output

AD1

Price level (P)

Increase in AD Decrease in AD


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AS curve

AS

Y Y1

P

P1

Price level (P)

Real GDP/ Real income0


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SAS

Y1 YFE

P

Price level (P)

Real GDP0

Keynesian range Intermediaterange

Vertical range

Physical Limit


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TYPES OF INFLATION/CAUSES

1.DEMAND PULL INFLATION

Exscess demand @too much $ over few goods

DD faster than SS

High DD ~ caused by high levels of AE.

Economy as a whole, if aggregate demand AD> AS pressure on

prices to rise.


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Y1 Y2

300

700

AE

Income

450AE inf

AE feInflationarygap

Keynesian Model : Demand pull inflation


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Real GDP

AD1

AD2

ASGeneral Price (P)

Pe1

Pe2

Ye2Ye10

DEMAND PULL INFLATION AD /AS MODELEquilibrium at AD = ASThe increase in AD will result in the AD1 curve shifting to the right,to AD2AD > AS~shortage of goods and services ~pushes the general pricesto increase.Classical range of the AS curve (as the economy approaches full

capacity).


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Cost push Inflation

due to higher cost of production.

Growth in wages in excess of productivity growth.

Increase in the domestic prices of imports.

Increases in oil prices.

Increases in government charges and taxes.

Lack of competition and efficiency.

Technological and structural change.


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Real wages income at constant prices withthe effect of inflation discounted.

AS

General Price (P)

Real GDP0Ye1 Ye

Pe

Pe1

AS1

AD


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Equilibrium AD = AS.

cost increases AS curve will shift to the left to AS1.

Disequilibrium, AS < AD ~shortage of goods and services.Therefore it pushes the general prices to increase.

cost of production output

Decreasing supply puts pressure on prices. Continuous shortagewill then cause inflationary pressure to occur.


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Relevant video

http://www.youtube.com/watch?v=bibMshyRabE


20/23

OTHER CAUSES OF INFLATION

An increase in the money supply

A depreciation of the MYR

Budget deficits

Decreased interest rates

Protection

Expectations of inflation


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Year 1 (base) Year 2 Year 3

Expenditure PriceIndex

$95.80100

$117.20 $122.60

Given the following of expenditure, calculate the price index for years 2 and 3.Answer :

Answer :Price index Year 2 = AE in year 2 100

AE in base year

= 117.2 10095.80

= 122.3

This means that prices in Year 2 have risen 22.3% since the base year.

Price index in Year 3 = 122.60 10095.80

= 128This means that prices in Year 3 have risen by 28% compared to the base year.

If you wish to calculate the yearly inflation rate in Year 3:

Inflation rate in Year 3 = 128 - 122.3 100122.3

= 4.7%

MEASUREMENT OF INFLATION


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EFFECTS OF INFLATION External stability

Business confidence falls

Income distribution (inequality in income)

Industrial disputes

Taxation receipts rise

Foreign investment discouraged

Expectation of inflation


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GOVERNMENT ACTION TO REDUCEAD

Contractionary Fiscal Policy (Budget Surplus)

Contractionary Monetary Policy

External Policy

Microeconomic Reform (MER)

inflation 2

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