Assignment of Inflation

Submitted to: Prof. Arshad Baig

Submitted by: (Group: 02)
Tayyaba Akram R2F18BSCH0007
Sahrish Akhtar R2F18BSCH0015
Mariha Iqbal R2F18BSCH0011
Gulfishan Tahir R2F18BSCH0010
Naila Mahboob R2F18BSCH0028
Arifa Asrafi R2F18BSCH0025
Asif Saeed R2F18BSCH0031

Section: CF-118

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PUNJAB GROUP OF COLLEGE RAHIM YAR KHAN
CAMPUS

“ Inflation is taxation
without legislation.”
 Definition:
“ Inflation is a measure of a general increase of the
price level in an economy, as represented typically by an
inclusive price index, such as the Consumer Price Index in the
United States.”
The term indicates many individual prices rising
together rather than one or two isolated prices, such as the price
of gasoline.

 Types of Inflation


 Creeping inflation
The rate of inflation doesn’t exceed the rate of
production growth, creeping inflation is < 10%

 Galloping inflation
The rate of inflation exceeds the rate of
production growth, Galloping inflation is from 10% to 100%.
Money loose purchase power, people hold as little money as
possible.
 Hyperinflation
Is inflation that is "out of control", a condition in
which prices increase rapidly as a currency loses its value.

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Hyperinflation is over 100% per year. Prices as well as wages are
extremely erratic. Money have no value and barter trade emerges
(barter means the exchange of good for good). Example:
Germany after I.WW, Hungary after II.WW.

 Open inflation
If economic imbalance is accompanied with rising
price level.
 Suppressed inflation
If state authorities damp or even stop the rise of
price level by administrative means. Such situation is followed by
existence of scarce commodities, shadow economy etc.
In such cases the provision of basic necessities
such as agricultural products is set by the government by
introducing price controls on commodities
 Hidden inflation
government imposes strict controls to curb
price inflation, producers are forced to sell the products at the
prices required.
Producers cannot sell the commodity at
higher prices to get the profit, therefore, lower on the quality of
products. This means that employers are selling lower quality
products at higher prices inflation is hidden.

 Measure of inflation
There are two ways to measure inflation
 Price index level :
o Expresses the level of prices of goods traded in economy at
the same time
o Price index is calculated for particular market basket for

examined periods.

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  The change of price index level within time is the
rate of inflation:
o Consumer price index
o Producer price indexes 
o Wholesale price indexes
o Commodity price indexes

 CPI
“ Consumer price index ’’
- The most often used index
- Measures the price of a selection of goods purchased by a
"typical consumer".
- It is a statistical time-series measure of a weighted average of
prices of a specified set of goods and services purchased by
consumers.
- It is a price index that tracks the prices of a specified basket of
consumer goods and services, providing a measure of
inflation.

 Steps to measure CPI

(1) Selection of the Base Year (CPI = 100)

(2) Selection of CPI basket, Example of Consumer Basket,
weightage (to measure the importance of one item in
the basket).
(3) Collection of data on prices
(4) Calculation of CPI

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 Sum of all weighted price index
Weighted CPI CPIw =
Total price

CPIt + 1 - CPIt
The rate of inflation is determined as: r = x 100
CPIt
 Causes of Inflation
 Excess of money
- demand pull inflation
- extra money will increase some societal group’s buying power
- price end up rising at extremely high speed to keep up with
currency surplus
- storages are created
- Prices are raised due to higher demand
 Rise in production cost
- cost pull inflation
- raw materials increase in price
- cost of production increasing
- company increasing prices to maintain their profits
- rising labour costs can also lead to inflation
 International lending and national debt
- as nations borrow money , they have to deal with interests
- causes price to rise as a way of keeping up their debts
- a deep drop of the exchange rate can also result in inflation , as
governments will have to deal with differences in the
export /inport level
 Federal taxes
- As the taxes rise ,suppliers often pass on the burden to the
consumer

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 - The catch ,however, is that once price have increased, they
rarely go back ,even if the taxes are later reduced

 Effects Of Inflation
An increase in the general level of prices implies a decrease in the
purchasing power money. That is, when the average price level rises,
each monetary unit buys fewer goods and services. Also, the effects of
inflation are not distributed evenly in the economy and as a
consequence there are hidden costs for some and benefits to others.
Negative effects of inflation
High and unpredictable inflation rates are regarded as harmful
to an overall economy. They add inefficiencies in the market, and make
it difficult for companies to budget or to plan long-term. Uncertainty
about the future purchasing power of money discourages investment
and saving. With high inflation purchasing power is redistributed from
those on fixed nominal income, such as pensioners, towards those with
variable incomes whose earnings
may better keep up with inflation .High inflation can prompt employees
to demand rapid wage increases to keep up with consumer prices. In
the cost push theory of inflation, rising wages in turn can help fuel
inflation. Inflation can also lead to massive demonstrations and even
revolution.
Food inflation, for example, brought abou the Tunisian and
Egyptian revolutions in 2011. Hyperinflation is a term used when
inflation gets out of control (in the upward direction). It can grossly
interfere with the normal working of the economy, hurting its ability to
supply goods. Also, with inflation, lenders and depositors who are paid
a fixed rate of interest on loans or deposits will lose purchasing power
from their interest earnings, while their borrowers benefit.

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Positive effects of inflation
We know that nominal wages are slow to adjust
downward. This can lead to prolonged disequilibrium and high
unemployment in the labour market. Since inflation allows real wages
to fall even if nominal wages are kept constant, moderate inflation
enables labour markets to reach equilibrium
faster. Also, if an economy finds itself in a recession with already low,
or even zero nominal interest rates, then, the central bank cannot cut
rates further in order to stimulate the economy. The situation is known
as the liquidity trap. So a moderate level of inflation tends to ensure
that normal interest rates stay sufficiently above zero so that when the
need arises the central bank can reduce the nominal interest rate.
Various economists observe that moderate inflation, once its
expectation is incorporated in normal interest rates, would give those
interest rates room to go both up and down in response to shifting
investment opportunities, on savers’ preferences and thus allow
financial markets to function in a more normal fashion.

 Stopping the inflation

There are a number of methods which have been suggested

stop inflation.
Managing the wages and prices – determined by state income
policy .

Stimulating market competition – e.g. antimonopoly regulations.

Fiscal and monetary policy – e.g. central banks can affect

inflation to a significant extent through setting interest.

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 Conclusion
It is difficult to justify inflation from an ethical point of view.
Utilitarians will well note that the punitive damages caused by inflation
(regressive wealth transfers and the instigation of the business cycle)
outweigh the alleged benefits which are primarily limited to reducing
the real value of debt owed. Natural rights theorists must accept that
inflation is a form of taxation, and as such are left in a position that if
they view direct taxation as an involuntary redistribution of wealth they
must view the result of inflation as the same. Kant’s categorical
imperative suggests that even low levels of inflation must be ethically
suspect. There is a general disdain for the redistributions and loss of
wealth apparent during hyperinflationary situations, such as the recent
episode in Zimbabwe. Yet this is only a difference of magnitude and not
of kind relative to the
lower levels of inflation experienced today by almost all developed
countries. If the original basis of inflation cannot be justified, avoiding
paying it cannot be considered ethically suspect. Money’s three distinct
roles – as medium of exchange, store of value and unit of account –
allow for three methods to avoid paying such a tax. Striking contracts in
terms of a good other than the good being inflated allow the relevant
parties to avoid valuational changes due to inflation. Using an
alternative good (or basket of
goods) as a unit of account allows an individual to ensure future cash
flows retain their real value. Holding savings in the form of a good
distinct from the inflated currency also allows one to avoid purchasing
power loses. Investors often pursue this option today – knowingly or
not – as individuals hold assets in goods that act as inflation hedges.
There are however some practical problems to avoiding inflation,
especially concerning
the medium of exchange function of money. People must accept the
legal tender money for settlement of contracts, even though the

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contract is denominated in another good. When, for instance, a loan
has been contracted in ounces of gold, the debtor has the right to pay
the loan back in fiat dollars. This leads to a significant increase in legal
uncertainty. Moreover, experiments to introduce alternative media of
exchange encounter another difficulty due to the important network
effects of money. As the government demands the legal tender money
through its direct taxation and spends it later, it creates an important
demand and use for the legal tender money. Due to the sheer size of
the government in the economy and the engrained network effects of
media of exchange, it is difficult to introduce a competing medium of
exchange in
order to avoid inflation.

( words:1,664)

The End

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