Transcript Calculation of Inflation

The Study of Inflation
GPL1
GPL0
Pg.325 Moynihan
Definition
“General and sustained rise in the
level of prices of goods and
services.”
Moynihan
Calculating of Inflation
To calculate rate of price inflation, we
calculate the average percentage
change in the prices of all goods and
services, from one point in time to
another, usually from 1 quarter to
another or from 1 year to another.
Calculation of Inflation
We usually track the price fluctuation of a
basket of goods.
In the case of Singapore the basket of
goods consist of 6,500 brands or variety of
goods and services.
Calculation of Inflation
Using a Weighted Average Price Index
Year 0 – Base Year
Pg. 330 Moynihan
Calculation of Inflation
Using a Weighted Average Price Index
Year 1 – (1 year after the base year)
Pg. 330 Moynihan
Calculation of Inflation
(Non weighter average)
Year
CPI
Infltion Rate
2000
2000
0
2001
2500
A
2002
3000
B
Qn 1: What is the inflation rate year on year (yoy)
from 2000 to 2001 and from 2001 to 2002?
2000 – 2001 is 25%: (2500 – 2000)/2000 X 100
2001- 2002 is 20% : (3000 – 2500)/2500
Qn 2: What is the inflation rate year at the end of
2002 as compared to the base year?
Base year 2000 to 2002 is 50% (3000
– 2000)/2000X 100
Reasons Why High Inflation Is Not Good for an
Economy
1.Purchaing Power will fall. People will save less and instead spend now as the value
of their money will be less. With less savings, the banks will have less funds to lend to
firms for investments and as such economic growth will be hindered.
2.Reduces competiveness of firms and is highly inconvenient as firms have to
constantly change their pricing
3.A country can lose its export competitiveness as compared to the lower cost product
of other countries exports
4.Diminishes the value of Money.
a. Money as a medium of exchange for goods and services will become unreliable.
b. Money as a unit of account – how many goods money can buy has to be constantly
adjusted as less and less can be bought
c. Money as a store of value – The same amount of money can buy less goods. People
will find their savings eroded when prices rise.
d. Money as a standard of deferred payment – Banks will give less loans and business
will give less credit payment as the value of money they received later will be less
than what they lend to them in the beginning.
Is Inflation Always Bad for the Economy?
AS
Mild inflation (less than 5% increase in GPL) is
beneficial to the economy as it is a signal to producers
that there is growth in the economy and as such profits
to be made thereby causing them to increase
production.
Is Inflation Always Bad for the Economy?
AS
Galloping(double / triple digit increase) or hyper
(1000% increase) inflation however is not good for the
economy.
The Long Run Aggregate Supply Curve
1. So far you have assumed that all AS is upward sloping:
SRAS
LRAS
LRAS
AD1
AD0
The AS that we have used so far is in fact
a short run AS (SRAS) where we can
increase the use of existing resources up
to the limit of a country’s resources.
Qn: But in the long run, were resources is
limited, how does the long run AS (LRAS)
look like? Hint: How does the supply
curve for a crop, like rice, look like (think
of gestation period)
As such when AD increases, there
will be no increase in ouput (no GDP
growth) as the LRAS is vertical.
Demand Pull Inflation
LRAS
GPL1
GPL0
SRAS
B
1. Excessive expenditure
from C,I,G & X. causes AD to
shift to the right
2. When AD increases
and shift from AD0 to
AD1 it give rise to
increase in GPL
A
AD1
AD0
signaling demand
pull inflation.
Definition:
Demand Pull inflation occurs when aggregate demand, for goods and
services exceeds aggregate supply. ie: AD (point B) > AS (point A)
This type of inflation happens when there has been excessive growth in
aggregate demand and there is an inflationary gap (A-B)
Demand Pull Inflation Application
Question.
Qn: Explain, using an AD/AS diagram,
how increasing income of the Chinese
To Hand Up
citizens has caused demand pull
Dylan Koh
inflation to arises in China.
Dilan Lee
Winnie
Xan
Melvin
Xinyu
Demand Side Policy Application Question
Barclay's Bank is presenting the following
question today. The question is:
"With the aid of a diagram, evaluate the
effectiveness of demand side policies to
make exports more competitive in a country
that is suffering high inflation" (8 marks).
*Members from Sumitomo and Deutsche
Bank are to comment.
Cost Push Inflation
SRAS
GPL1
B
GPL0
A
AD1
AD
Definition: Sustained
increase in price of goods
and services, caused by
the passing off
increased production
costs to the consumers by
the producers.
Representation. This
can be shown by an
inward shift of the short
run aggregate supply
curve which leads to a
contraction in the real
output (and economic
growth), an also an
increase in the general
price level.
Causes of Cost Push Inflation
1. Increase in the prices of factors of production eg. Fuel Oil,
Resource like plastics, tin, copper that is required for the
production process. If these resources are imported at a
higher price, we call this imported inflation.( be careful of
misconception here – nothing to do with AD imports here)
2. Increase in the wages of labour. ( We call this wage push
inflation)
3. Firms desiring to increase push for profits and hording
resources (as in a monopolistic or oligopolistic market
structure) causing prices of goods to increase.
Imported inflation, wage push and profit push are all
different form of cost push inflation.
Cost Push Inflation - Solution
SRAS
GPL0
GPL1
Solution to Cost Push
Inflation:
?
A
B
AD1
AD
SUPPLY SIDE
POLICIES
Cost Push Inflation – Teaser 1
1. The
international price of fuel oil has
increase by 15% since last year. Explain how
this will affect Singapore’s exports?
Gen to present
Ans: As fuel oil is imported by domestic firms as a factor of
production, an increase in price will increase the cost of
production of many firms giving rise to imported inflation (a
form of cost push inflation)
This implies a leftward shift of the SRAS curve upwards (or
leftward) giving rise to an increase in GPL.
Ultimately the prices of Singapore exports will become more
expensive vis-à-vis imports causing Singapore exports to lose
its competitiveness.
Hand Up
Dilan Koh
Dylan Lee
Eunice
Mandy Ho
Melvin
Adi
Amelia (pls
remember
to write the
question)
Cost Push Inflation – Teaser 2
2. The government of China recently decided
to remove the monopoly power of state owned
enterprises. Explain how this would benefit
China’s exports. (5 points)
Hand Up
Gina
Bernice
Benedict
Charmain
Ans: A monopoly market structure is such that the monopolist
Angie
is able to reduce production and cause prices to increase as
Alex
the monopolist maximizes profits. (1)This gives rise to cost
Sue Ning
push inflation. (1)
Kenneth
(pls
By removing monopoly power, the government is increasing
remember
competition(1) in the market (this is a supply side policy)
to write the
causing firms to use resources more efficiently thereby
question)
achieving allocative and productive efficiency (1). Domestic
Chinese firms can produce cheaper goods/services as
compared to imports. This increases the export
competitiveness of Chinese goods and will give rise to greater
economic growth. (1)
(*red words are required key phrases)
Wit to process this answer.