Types Of Inflation And Their Implications Economics Essay


Inflation is defined as the relentless upward motion of the monetary value degree.

The mean degree of monetary values is called the monetary value degree. It is measured by a monetary value index. A monetary value index measures the mean degree in an earlier period, called the base period.

The rising prices rate is the per centum alteration in the monetary value degree. The expression for the one-year rising prices rate is:

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Inflation rate =

Current twelvemonth ‘s monetary value degree – Base twelvemonth ‘s monetary value degree

x 100 %

Base twelvemonth ‘s monetary value degree

1.2 Types Of Inflation

1.2.1 Demand-pull rising prices

This type of rising prices is caused by an initial addition in sum ( i.e. entire ) demand. An addition in aggregative demand can be due to an addition in the money supply, authorities purchases, investing outgo or exports. It is normally associated with conditions of full employment.

If the economic system is already at full employment, when there is a farther addition in aggregative demand, it increases existent GDP every bit good as the monetary value degree. When the existent income is above full employment, the pay rate will decidedly lift and short-term sum supply lessenings, so existent GDP lessenings but the monetary value degree keeps lifting.

If aggregative demand keeps increasing, pay continues to lift and the monetary value degree rises in an on-going rising prices procedure. Figure 1 illustrates a demand-pull rising prices spiral.

Figure 1 Repeated additions in demand create a price-wage spiral.

1.2.2 Cost-push rising prices

This type of rising prices is caused by an addition in costs. The rise in costs may come from a figure of different beginnings, e.g. an addition in money pay rates or the monetary values of natural stuffs.

When costs rise, the short-term sum supply will diminish, taking to a lessening in existent GDP and a rise in the monetary value degree. When existent GDP falls, the unemployment rate rises above the natural rate. We call such a state of affairs stagflation.

To reconstruct full employment, the authorities may try to increase aggregative demand. Such action may take to a farther addition in the monetary value degree and as a consequence of repeated stimulation, a monetary value spiral may organize.

Figure 2 illustrates a cost-push spiral.

Figure 2 Oil monetary value additions lead to cost-price rising prices spiral.

1.2.3 Imported rising prices

This type of rising prices is caused by an addition in the monetary values of imported goods or natural stuffs, taking to an addition in the cost of production and hence the monetary values of the concluding goods and services.

It is peculiarly of import to a state with a little, unfastened economic system which depends to a great extent on foreign supply of natural stuffs.


There are two common ways of bespeaking alterations in the monetary value degree: a monetary value index and an inexplicit GNP deflator.

2.1 Consumer Price Index

The consumer monetary value index ( CPI ) is the most normally used. The monetary value index takes a value of 100 in the base period. The CPI provides steps of the comparative alteration over clip in the entire cost of a specified basket of goods and services. It merely reflects the monetary value motions as the basket is fixed in footings of measure and quality of the points it contains.

There are three separate CPI series associating to different degrees of income.

Index Seriess

Outgo Scope

Percentage Of

Families Covered

CPI ( A )



CPI ( B )



CPI ( C )



Composite CPI



The different series of CPI give indicants of the cost of life in different outgo forms.

CPI ( A ) gives thoughts about day-to-day necessities while CPI ( C ) tends to give information on the monetary values of luxury points.

2.1.1 How is the CPI obtained?

Every month, we have to happen the point index for each single point foremost, which reflects the alteration in monetary value of the points since the base period. Then, we find the leaden merchandise of the point and point index.


Outgo Weight

Item Index ( Period 1 )

Item Index ( Period 2 )


40 %




50 %




10 %



The CPI for Period 1 is calculated as follows:

CPI = 40 % x 100 + 50 % x 100 + 10 % ten 100

= 100

The CPI for Period 2 is calculated as follows:

CPI = 40 % x 105 + 50 % x 110 + 10 % ten 125

= 109.5

2.2 Implicit GDP Deflator

This monetary value alteration is measured as the ratio of money GDP to existent GDP. It differs from the monetary value index in that it includes all the goods counted in the GDP.

Let ‘s presume there are merely three goods in an economic system – books, oranges and autos. In the current period, nominal GDP is $ 2,096.75. If the current-period measures are valued at the base-period monetary values, we obtain a step of existent GDP that is $ 2,035. The GDP deflator in the current period is 103, which is calculated by spliting nominal GDP by existent GDP in that period and multiplying by 100.


Base Period

Current Time period


Monetary value


Monetary value




$ 20

$ 1,000

$ 21

$ 1,050



$ 1

$ 35

$ 1.05

$ 36.75



$ 500

$ 1,000

$ 505

$ 1,010

Nominal GDP

$ 2,035

$ 2,096.75



3.1 Unanticipated Inflation


Unanticipated rising prices refers to the state of affairs in which people can non right foresee the rising prices rate.

Unanticipated rising prices can either be at a higher or lower rate than anticipated.

The costs of unforeseen rising prices can be significant:

aˆ? Income distribution

Unanticipated rising prices redistributes income and wealth. If the existent rising prices rate is higher than the awaited rising prices rate, the existent involvement rate will fall below the existent involvement rate. This consequences in a redistribution of buying power from loaners to borrowers because loans are repaid with a lower existent value than they were borrowed.

When rising prices is unforeseen or under-anticipated, a autumn in the value of money will reassign buying power from those populating on fixed incomes and redistribute it to those who are able to set to a nominal income in gait with or even in front of rising prices, such as those workers with strong bargaining power.

aˆ? Disincentive to salvage

Negative existent involvement rates discourage people to borrow, and besides an strong incentive against salvaging.

aˆ? Distortion of economic behavior

Inflation can falsify consumer behavior by doing consumers to increase their disbursement and stashing trade good.

Inflation can besides falsify the behavior of houses and imposes costs upon them. If the rising prices rate rises at a rapid rate, houses will happen it hard to be after for the hereafter because of uncertainnesss environing costing and profitableness. Firms so may be tempted to deviate their financess out of productive investing into trade good billboard and bad activities.

3.2 Anticipated Inflation


Anticipated rising prices refers to the state of affairs in which people right predict the rate of addition in the general monetary value degree.

The costs of awaited rising prices are comparatively little. If rising prices is to the full anticipated, people can follow steps to cut down the impact of rising prices.

In that instance, monetary values, rewards, involvement rates, etc. , will all be adjusted to take into history the expected degree of rising prices. However, there are still welfare costs incurred by society. To continue the value of their hard currency retentions, people engage in active hard currency direction. All these will blow clip and attempt to understate their hard currency retentions and maximize the sum of money kept in other assets.

4. Unemployment


Unemployment can be defined as the status in which workers that are willing and able to work make non presently have occupations and are actively looking for work.

The unemployment rate is the ratio of the figure of unemployed individuals to the labour force. The labour force refers to people belonging to the on the job age who are economically active.


Underemployment can be defined as the state of affairs in which workers are working but are non being utilised to their full capacity.

For illustration, some workers may keep a parttime occupation but prefer to work full clip ; other workers may be keeping occupations that are far below their capablenesss and they want to work more hours.

4.2 Cost Of Unemployment To Society

Society pays a monetary value for unemployment:

aˆ? Waste of human resources

Unemployment represents a waste of human resources to the whole society in footings of the loss of possible end product if those workers were employed.

aˆ? Deterioration

Peoples who are unemployed will endure from different grades of defeat and

depression. There is besides a loss of assurance and motive. Therefore, the

long-run unemployed may happen it hard to derive employment once more.

aˆ? Financial load to the community

The authorities has to supply societal and fiscal aid to the unemployed which will increase the fiscal load of the whole community.

aˆ? Tax gross

The wages revenue enhancement gross received by the authorities falls as the sum of unemployed workers additions.

aˆ? Social jobs

When unemployment rises, many societal jobs such as divorce, self-destruction and stress-related diseases emerge.

5. TYPES OF Unemployment

Unemployment comes in different signifiers.

5.1 Frictional Unemployment


Frictional unemployment refers to the clip slowdown involved when people change their occupations, either voluntarily or because they are dismissed or made redundant.

Peoples can non alter from one occupation to another instantly. This may be due to miss of information, for illustration if there is mismatching of information between the employers and the employees about the handiness of suited places.

Searching for the right occupation and employers takes clip.

5.2 Structural Unemployment

The development of the economic system is imbalanced in that some industries are spread outing while some are worsening, which leads to a structural instability in the demand for labor.


Structural unemployment happens when labor is occupationally immobile, go oning to seek employment in the worsening industries even though opportunities of happening work are really slender. These workers therefore become structurally unemployed.

5.3 Cyclic Unemployment


Cyclic unemployment is due to a lessening in the aggregative demand for goods and services during recessions.

When the economic system falls into recession, consumer demand falls. Firms would so be unable to sell their current degree of end product. They start to cut down end product, so layoffs rise and new hires decline in a broad assortment of trade and industries. Cyclic unemployment additions during this period.

5.4 Natural Rate Of Unemployment


The natural rate of unemployment refers to the state of affairs in which the labor market is in long-term equilibrium, when all workers and employers have reflected all alterations in the economic system.

This is merely an estimated rate of unemployment that would anticipate to predominate in the long tally.

The natural rate of unemployment should non reflect cyclical unemployment and therefore it consists of lone frictional and structural unemployment.

5.5 Full Employment

Since the economic system is dynamic and continually altering, new occupations are created and old 1s are destroyed, people are traveling in and out of the labor market every twenty-four hours.

There is ever some unemployment in any economic system, taking into history of the normal turnover in the labor market.


The economic system is considered to be at “ full employment ” when the existent unemployment rate is equal to the natural rate of unemployment.


We are interested in long-run growing because it brings lifting income to each individual.

Preconditions for economic growing are:

aˆ? markets for increased end product

aˆ? belongings rights clearly defined

aˆ? pecuniary exchange, i.e. trade between economic systems

Activities that generate economic growing are:

aˆ? Salvaging and investing in new capital: New capital disbursement increases the capital per worker and additions existent GDP per hr of labor ( i.e. labour productiveness ) .

aˆ? Investment in human capital: The accumulated accomplishment and cognition of human existences is the most cardinal

beginning of economic growing.

aˆ? Discovery of new engineerings: The find and application of new engineerings and goods will increase labour productiveness.

6.1 Growth Accounting

Growth accounting is used to cipher how much existent GDP growing consequences from growing of labor and capital and how much is attributable to technological alteration.

The measure of existent GDP supplied ( Y ) depends on three factors:

aˆ? Quantity of labor ( N )

aˆ? Quantity of capital ( K )

aˆ? State of engineering ( T )

A cardinal tool of measuring is the aggregative production map: Y = F ( N, K, T )

Growth accounting divides growing into two constituents:

aˆ? Growth in capital per hr of labor

aˆ? Technological alteration includes everything that contributes to labor productiveness growing that is non included in growing in capital per hr

6.1.1 Labour productiveness

Labour productiveness is existent GDP per hr of work which is equal to existent GDP divided by aggregative labour hours. It determines how much income an hr of labor generates.

Figure 3 How productiveness grows

6.1.2 The productiveness map

The form of the productiveness map reflects the jurisprudence of decreasing returns, which states that as the measure of one input increases with the measures of all other inputs staying the same, end product will increase, but by of all time smaller increases.

Using the jurisprudence of decreasing returns to capital, the jurisprudence states that if a given figure of hours of labor usage more capital, the extra end product that consequences from the extra capital gets smaller as the sum of capital additions.

6.1.3 Classical growing theory

This theory suggests that existent GDP growing is impermanent and that when existent GDP per individual rises above the subsistence degree, a population detonation finally brings existent GDP per individual back to the subsistence degree.

Thomas Malthus is given most of the recognition for this theory, which we call the Malthusian theory.

A growing in existent GDP will trip a greater demand for labour and therefore the existent pay rate additions. But the classical economic experts believe that this new state of affairs can non last because it will bring on a population detonation.

6.1.4 Neo-classical growing theory

This theory holds that existent GDP per individual grows because technological alteration induces salvaging and investing that makes capital per individual grow.

Technological alteration can be understood as follows:

aˆ? The rate of technological alteration influences the rate of economic growing, but economic growing does non act upon the gait of technological alteration. Technological alteration consequences from opportunity.

aˆ? These technological progresss bring new net income chances. Businesss expand and new concerns are created to work the freshly profitable engineerings. Investing and nest eggs addition. The economic system enjoys new degrees of prosperity and growing. Harmonizing to the neo-classical growing theory, the prosperity will prevail because there is no classical population growing induced to take down rewards.

Figure 4 Neo-classical growing begins.

However, growing will halt if engineering stops progressing for two grounds:

aˆ? high net income rates

aˆ? decreasing returns to capital because farther investing does non warrant a sensible return.

6.1.5 Target rate and long-run economy

Throughout the procedure of technological promotion, existent GDP grows but the growing rate gradually decreases and finally ends. Ongoing capital progresss are invariably increasing the demand for capital, raising the existent involvement rate and bring oning salvaging. The procedure repetitions every bit long as engineering progresss, making an ongoing procedure of long-run economic growing.

In world, this convergence is slow and does non look imminent for all states.

Chapter Review

aˆ? Unanticipated rising prices redistributes income and wealth.

aˆ? The measure of existent GDP supplied ( Y ) depends on the measure of labor ( L ) , capital ( K ) and the province of engineering ( T ) .

aˆ? The form of the productiveness map reflects the jurisprudence of decreasing returns.

What You Need To Know

aˆ? Inflation: The relentless upward motion of the monetary value degree.

aˆ? Unanticipated rising prices: A state of affairs in which we can non anticipate or anticipate right the rising prices rate.

aˆ? Unemployment: A state of affairs in which workers who are willing and able to work make non hold occupations, and are actively looking for work.

aˆ? Underemployment: A state of affairs in which workers are working but are non being utilised to their full capacity.

aˆ? Frictional unemployment: Time-lag involved when people change their occupations, either voluntarily or because they are dismissed or made redundant.

aˆ? Natural rate of unemployment: The state of affairs in which the labor market is in long-term equilibrium, when all workers and employers reflect all alterations in the economic system.

aˆ? Full employment: Actual unemployment rate is equal to the natural rate of unemployment.

Work Them Out

1. Which group will derive in an unforeseen rising prices?

A pensionaries

B nest eggs deposit-holders

C fixed-income earners

D insurance companies

2. If the Consumer Price Index A increases at a faster rate than the Consumer Price Index C, we may state that

A they are non good indexs of rising prices

B the belongings market performs much better than the overall economic system

C the low-income group suffer more than the high-income group

D the existent income is falling

3. When the nominal Gross national product additions at a faster rate than the existent GNP, we may state that

A the criterion of life is increasing

B the cost of life is increasing

C the cost of life is diminishing

D the population is diminishing

4. Which of the followers is NOT an consequence of rising prices?

A a alteration in penchants in favor of physical goods

B a possible addition in authorities gross from income revenue enhancements

C an addition in bad activities

D a redistribution of income from the borrowers to the loaners

5. Which one of the followers could non be the initiating cause of demand-pull

rising prices?

A an addition in the money supply

B an addition in exports

C an addition in the monetary values of imported goods and services

D an addition in investing outgo

6. When the pay rates and the rising prices rate addition at the same rate

A workers will be better off

B nominal pay rates will lift faster than the existent pay

C there will be no alteration in existent rewards

D existent rewards will be higher than nominal rewards

7. An awaited rising prices

A has no consequence on wealth-redistribution

B will non diminish the cost of life

C is ever caused by financial policy

D is ever caused by international trade shortage

8. Which of the followerss is non a necessary stipulation for economic growing?

A limitations on private ownership of resources

Bacillus markets

C private belongings rights

D exchange with money

9. The sum of cognition that a worker possesses can be classified as

A money capital

B human capital

C physical capital

D intrinsic capital

10. The productiveness map shows that technological advancement causes

A an addition in the degree of existent GDP per hr of work at any degree of capital input

B no alteration in the degree of existent GDP per hr of work at any degree of capital input

C a lessening in the degree of existent GDP per hr of work at any degree of capital input

D an addition in the labour input in production

Short Question

The following tabular array shows the consumer Price Index of a conjectural state for the period of 2005-08:


Annual Average Index









( Base twelvemonth 2004 = 100 )

Define rising prices

Calculate the per centum addition in the monetary value degree as measured by the CPI

( I ) in 2006 as compared with 2005.

( two ) in 2007 as compared with 2006.

( three ) in 2008 as compared with 2007.

Did the state experience rising prices for the above period? Explain.

Explain three possible causes of rising prices.

Classify the undermentioned state of affairss as frictional unemployment, structural unemployment, or cyclical unemployment, and briefly explain your pick:

( a ) Jane is laid off during a recession. Jane is willing to work even at a pay somewhat less than current rewards but no occupations are available.

( B ) An accountant refuses a occupation offer and decides to look for another occupation which has a better wage.

( degree Celsius ) A manner interior decorator is laid off when the house relocates its production to other states.

( vitamin D ) A clerk is made excess due to the installing of new automatic payment system.

( vitamin E ) James realises that the wage at his current occupation does non maintain up with rising prices. He quits his occupation to look for a better one elsewhere.


1. Would the undermentioned individuals gain or lose during an unforeseen rising prices? Explain.

( a ) a individual who holds bond and receives fixed involvement every twelvemonth

( B ) a man of affairs borrows a 2-year fixed-interest loan

( degree Celsius ) a retired civil retainer who receives his pension at a fixed monthly rate

( vitamin D ) a worker who marks a 3-year contract with his employer that his wage will be the same for a 3-year period

2. What are the suited authorities policies for each of the undermentioned types of unemployment? Explain briefly.

( a ) structural unemployment caused by a alteration in demand

( B ) cyclical unemployment

( degree Celsius ) frictional unemployment



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