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# ASSIGNMENT OF PROJECT DEVELOPMENT, EVALUATION & FEASIBILITY

## KARACHI UNIVERSITY BUSINESS SCHOOL UNIVERSITY OF KARACHI

What is Inflation?
Inflation is a rise in the general price level and is reported in rates of change. Essentially what this means is that the value of your money is going down and it takes more money to buy things. Therefore a 4% inflation rate means that the price level for that given year has risen 4% from a certain measuring year. The inflation rate is determined by finding the difference between price levels for the current year and previous given year. The answer is then divided by the given year and then multiplied by 100. To measure the price level, economists select a variety of goods and construct a price index such as the consumer price index (CPI). By using the CPI, which measures the price changes, the inflation rate can be calculated. This is done by dividing the CPI by the beginning price level and then multiplying the result by 100.

INTRODUCTION:

Inflation is one of the key factors in any nations economy. Inflation shares relationships with many other factors that greatly affect the business and trading community in a nation. 1. Inflation and Interest Rates: If the local currency loses purchasing power then possible earnings by the lender might go down as well, therefore; as inflation rises, interest rates rise as well. 2. If interest rates increase, most of the security markets will see their prices affected as well. 3. Stock, Bonds, and the local Economic Indicators will see their numbers affected simply by money losing its purchasing power.

In this era of globalization, inflation crosses borders and affect to both developing and developed countries and now inflation is a major problem of todays world including Pakistan. It is generally felt that for several years, Pakistan has had double digit inflation.

Why does inflation matter? The impact of inflation on trade and businesses depends in part on whether inflation is anticipated or unanticipated:

Anticipated inflation: When people are able to make accurate predictions of inflation, they can take steps to protect themselves from its effects. For example, trade unions may exercise their collective bargaining power to negotiate with employers for increases in money wages so as to protect the real wages of union members. In this way, people can help to protect the real value of their financial wealth. Companies can adjust prices and lenders can adjust interest rates. Businesses may also seek to hedge against future price movements by transacting in forward markets. For example, most of the major airlines buy their aviation fuel several months in advance in the forward market, partly as a protection against fluctuations in world oil prices.

Unanticipated inflation: When inflation is volatile from year to year, it becomes difficult for traders and businesses to correctly predict the rate of inflation in the near future. Unanticipated inflation occurs when economic agents (i.e. traders, businesses and governments) make errors in their inflation forecasts. Actual inflation may end up well below, or significantly above expectations causing losses in real incomes and a redistribution of income and wealth from one group in society to another.

Money Illusion It is a fact of life that people often confuse nominal and real values in their everyday lives because they are misled by the effects of inflation. For example, a worker might experience a 6 per cent rise in his money wages giving the impression that he or she is better off in real terms. However if inflation is also rising at 6 per cent, in real terms there has been no growth in income. Money illusion is most likely to occur when inflation is unanticipated, so that peoples expectations of inflation turn out to be some distance from the correct level. When inflation is fully anticipated there is much less risk of money illusion affecting both individual employees and businesses.

Effects of Inflation in Pakistan As described by the institute of Development Economics in Pakistan, inflation has had some of the following broad effects in the Pakistani living quality.

1. Increasing vulnerability and fall in real income of lower, middle and fixed income segments of the society. 2. uncertainty about future scenario of the business environment and instability of the financial system 3. Erosion of business and investors confidence 4. Slowing down of real economic activities 5. Investment 6. Economic growth 7. Employment 8. Businesses and Trade

IMPACT OF INFLATION ON TRADE & BUSINESS 1. Disrupt Business Planning: More generally, inflation can disrupt business planning. Budgeting becomes difficult because of the uncertainty created by rising inflation of both prices and costs and this may reduce planned capital investment spending. Lower investment then has a detrimental effect on the economys long run growth potential.

2. Reduces the value of domestic output: An increase in the rate of monetary expansion generally reduces the value of domestic output and alters the composition of domestic production. The result is a change in the pattern of international comparative advantage and trade flows. The initial depreciation of the exchange rate following an increase in the rate of monetary expansion is accompanied by a trade surplus and capital outflow, while the subsequent depreciation is accompanied by a trade deficit. 3. Layoff workers: A destabilizing effect of inflation on businesses is that it can cause consumers and investors to changer their speeding habits. When inflation occurs, people tend to spend less meaning that factories have to lay off workers because of a decline in orders. 4. Speculation by some businesses to take advantage: Another destabilizing effect of inflation is that some people choose to speculate heavily in an attempt to take advantage of the higher price level. Because some of the purchases are high-risk investments, spending is diverted from the normal channels and some structural unemployment may take place. 5. Inflation alters the distribution of income: Businesses that deal in providing loans are generally hurt more than borrowers during long inflationary periods which mean that loans made earlier are repaid later in inflated rupees.