INFLATI

ON
 THEORIES OF

INFLATIO
N
Demand-pull inflation or
“inflationary gap” inflation

Cost-push inflation
DEMAND-PULL INFLATION OR
"INFLATIONARY GAP"
• The most popular type of inflation
• Arises from excess of aggregate demand.
• Resulting in general price level rise.
• Expresses as 'too much money chasing too few
goods'.
• Typically occurs at or near full employment,
where all available resources are fully utilized.
• At full em ploym ent, all individuals, except the
unem ployed, are em ployed and earn incom e, leading to
high aggregate dem and for goods and services.
• Busi nesses can expand to m eet buyer dem and but cannot
do so in the short run.
• If total spending subsides, pressure on product supply
will decrease, reducing price rise or falling.
COST-PUSH INFLATION

• Is a rise in the general level of prices resulting from

an increase in the cost of production.
• Refers to the production side
• Higher input cost are “pushing” up food, clothing and
gas prices
• Any sharp increase in business production costs
can cause cost-push inflation.
• This means that upward pressure can be caused
by minimum wage, raw material, construction,
equipment prices, interest rate rise, and
electricity prices.
• Businesses can raise prices to increase profits.
 INFLATION AND
THE PURCHASING
POWER OF MONEY
When inflation occurs, the price levels rise
meaning more money are required to buy
certain basket of goods. This is a way of
saying that a certain amount of money will not
buy as much as i t di d before. One will wonder
how much a unit of money will be able to
purchase goods.
The Purchasing Power of Money indicates
how many market baskets of goods can be
purchased with one unit of money.
 EFFECTS OF

INFLATIO
N
1. Because unanticipated inflation alters the
outcomes of long-term projects, such as the
purchase of machine or an investment in a
business, it will increase the risk and retard
the level of such productive activities.
Unpredictable price increases can lead to personal
economic disasters, as decision-makers often forgo
long-term investments due to uncertainty. This can
result in mutually advantageous gains from trade
being lost and market efficiency being reduced, as
inflation rates fluctuate significantly.
2. Inflation distorts the
information delivered by prices.
• Prices provide crucial information about
relative scarcity of goods and services.
• Some prices can be easily changed, while
others, especially those set by long-term
contracts, require time delays.
• Unanticipated inflation changes can alter
relative prices and the general price level.
3. People will respond to high and
variable rates of inflation by
spending less and more time trying
to protect themselves from
inflation.
• Inflation's unpredictability can significantly
affect wealth.

• Business decision-makers' ability to forecast and

manage price changes becomes more valuable
relative to their ability as managers and organizers
of production.
CORE INFLATION
AND HEADLINE
INFLATION
CORE
INFLATION
Core inflation is a measure of average consum er
prices, often used as a complement to the Consum er
Price Index (CPI). It excludes volatile items and
provides a broad underlying trend in consum er
prices. Core inflation is influenced by money in the
econom y and monetary policy.
 HEADLINE
• Refers to the rate of change in the consumer price
INFLATION
index (CPI).
• CPI basket includes various consumer items
determ ined by the nationwide Family Income and
Expenditure Survey (FIES).
• Captures changes in cost of living based on price
movements in the basket of commodities and services
consum ed by a typical Filipino household.
APPENDIX TO CHAPTER 11

HOW TO ESTIMATE
CORE INFLATION
 EXCLUSION METHOD
• Computes core inflation by taking out the prices of a
fixed, pre-specified set of items from the CPI basket.
• Excluded components: Food and energy items,
considered volatile or susceptible to supply
disturbances.
• Markets related to these goods are prone to supply
shocks.
STATISTICALLY-BASED METHODS

• This method remove the impact of extreme or

outlier price changes (both positive and
negative) from the overall inflation rate.
• Set of excluded items changes monthly based on
extreme price movements
The most common statistical measures of core inflation
are the trimmed mean and weighted median.
 Trimmed Mean
It measure takes the average inflation rate after excluding a specified
percentage of extreme positive and negative price changes

Weighted Median
It simply takes the median inflation rate which corresponds to a
cumulative CPI weight of 50 percent from the highest-to-lowest
ranking.
 Both measures are derived from a highest-to-
lowest (or positive to negative) ranking of
individual price changes for each given month
 ECONOMETRIC
TECHNIQUES
Econometric techniques estimate core
inflation by calculating a statistical
relationship between inflation and other
economic variables, then using actual data
to generate monthly estimates.
 In the Philippines, official core inflation measure is
computed using the exclusion method. This approach
was chosen for the following reasons: ease of
construction; understandability by the general public;
easy replication and verification by others;
accountability and transparency of measurement; and
timeliness.
EXAMPLE OF THE NUMERICAL
COMPUTATION OF CORE
INFLATION BASED ON THE
OFFICIAL DEFINITION IN THE
PHILIPPINES