Inflation

 sustained rise in the general price level overtime

 value of money (-) >> real income (-)
 purchasing power (-)/ spending power (-)
 average prices are rising
Thus, government controls the inflation rate

4 types of inflation
1. Demand-pull inflation
 Caused by [AD > AS] during Boom
 Consumption (+) >> Output (+), Unemployment (-)
2. Cost-push inflation
 Caused by cost of production (+) >> price (+)
3. Imported inflation
 Caused by trade barriers>> Imports price (+) in RM, FG, Capita >> cost of production
(+) >> P (+)
4. Monetary causes of inflation
 Caused by money supply (+) >> easily available of loan
Harmful effect of inflation on Consumers, Firms, Economy
1) Consumers and Firms
 Shoe-leather cost –searching for the best – deal >> spend more time {represent an
opportunity cost}
 real income (-) due to money is worth less than before >> Purchasing power (-)
 Cost of living (+) due to need more money to buy same g&s>> Living standard (-)
 Fixed income earner >> real income (-) >> living standard (-)
 Confidence level (-) >> consumption (-)
2) Firms
 Menu cost – Changes in the price charged by the firm >> costly to firms >> workers have
to be paid for their time to reprice g&s
 Exporter - domestic price (+) >> international competitiveness (-) >> Export demand (-)/
export earnings (-) >> profits of exported firm (-)
 Importer – imports more expensive due to purchases power of money (-) >> essential
imports – raw material & food price (+) >> workers demand high wages>> cost of
production (+) >> Profit (-)
 Confidence level (-) >> investment (-)
3) Economy
 Export (-) >> output (-) >> negative Economic growth, unemployment (+), negative
impact on current account
Savers/ Lenders (Consumers, firms, governments
 Saving money is worth less than before
 Lose out from inflation if no change in interest rate
 Saving (-) >> bank lending to firms (-) >> Investment (-)>> future economic growth
  Borrowers gain from inflation because the money they need to repay is worth less than the
original value >> real value of debts (-)

Not harmful effect of inflation

i. Balance of payment – domestic inflation rate > other countries inflation rate >> harm >> less
competitive >> export revenue (-), import expenditure (+) >> Current account (negative)
Domestic inflation rate < other countries inflation rate >> not harmful >> more competitive
ii. Low and stable inflation rate >> not harmful >> AD (+) >> P (+) >> AS (+)
iii. If inflation is demandd-pull inflation >> AD (+) >> Employment (+) >> output (+) encourage
firms to expand due to increase in revenue, optimistic about future sale >> Investment (+) by
borrowing
iv. Government – Tax revenue (+) >> use other public services

Hyperinflation – very high level of inflation rates out of control/inflation rate very rapidly

Deflation

 sustained fall in general price level

 negative inflation rate
2 types of deflation {is deflation harmful to the economy?}
1. Benign deflation (non-threatening deflation)
 Caused by higher levels of supply of goods and services due to technological progress
 productive capacity (+) [by using supply-side policy]
 thus, general price level (-), National income (+)

2. Malign deflation (harmful to the economy)

 Caused by AD (-) During economic recession
 Consumption (-) >> unemployment (+)
 AD (-) >> the general price level (-) due to excess capacity(supply) in the economy >>
National income (-) >> Living standard (-)
Harmful to economy
 Unemployment (+) - AD (-) >> Output (-)>> Demand for labour (-)>> Job losses
 Bankruptcies - consumption (-) >> Sales revenue (-) >> Profit (-)>>investment (-)/not
covering cost of production/liabilities (-)
 Wealth effect – Profit (-) >>Dividends (-)>> Share price (-) >> wealth of shareholders (-)
 Debt effect (consumer and firms)– Borrowing >> real cost of debt (+), real interest rate
(+), real value of debt (+)
 Government debts –Government spending > Tax revenue >> Budget deficit >>
borrowing (+) >> national debt
 Consumer confidence (-) >> Consumers do postpone spending because of uncertainty
and consider and wait to fall in price in the future
Interest rate – determine the cost of borrowing / return from lending
Whether or not rise in interest rate may benefit on economy:
Benefit
→ Demand pull inflation (-) as AD (-) >> AS (-) >> Price level (-)
→ Cost-push inflation (-) as cost of production (-) due to firms cover the profit margin >> Price (-)
→ IR (+) >> ER (+) >> Import price of RM, FG, Foods (-) >> Less imported inflation
→ Inflation (-) >> purchasing power (+) >> Living standard (+)
→ IR (+) >> Saving (+) due to returns from saving >> More funds for investment of business >>
Investment (+)
Not benefit
→ For consumer - IR (+) >> Cost of borrowing (+) >> Amount of borrowing / demand for loan
(-)>> spending (-) saving (+), Consumption (-) due to interest repayment (+) with loans>>
Disposable income (-)
→ For Consumers with existing loans/mortgage - Disposable income (-) >> Consumption (-)
→ For Firm – Investment (-) due to borrowing (-) >> productivity (-) >> negative economic growth
→ Consumer (-) & Investment (-) >> AD (-) >> Negative economic Growth due to lower GDP
→ Unemployment (+) as output (-) >> Job losses >> DL (-)
→ IR (+) >> ER (+) >> Exports P > Import P >> value of net export (-) >> impact negatively on
Current account + not competitive in international competitiveness