Inflation

Inflation is the sustained increase in the general level of prices without real value. Below is all about inflation.

What are the problems with inflation?

1. Unknown future inflation

    

   • this leads to the riskiness of business venture as:

      

     • costs and revenues from the venture may not be index linked

        

     • high inflation leading to increased interest rates which threatens the short term viability of new business existing on borrowed funds.

    

2. increase prices (assuming the exchange rates are constant)

    

   • this makes exports expensive and imports cheap

      

   • with export decreasing and import increasing, this leads to the balance of payments difficulties

      

   • when exchange rates fall, import prices rise leading to inflationary pressures

    

3. disadvantages for those without index linked income

    

4. if the interest rate is not at least the inflation rate, then there is no incentive to save money

    

   • Therefore, investments decrease leading to slow economic growth

    

5. functions of money break down

What are the causes of inflation?

The causes of inflation are:

• Keynesians = excess demand
  Supply
• side = supply too low

What are the solutions of inflation?

In Keynesian economics the solution of inflation is to:

• decrease government spending so that the national level is at equilibrium (income = expenditure)

In the Supply side economics, the solution of inflation is:

• increase aggregate supply:
  • improve performance of labor (training, geography, no minimum wages)
  • improve economic incentives (equivalent to decreasing taxes)
  • privatization (increase competition, increase government revenue, widen share ownership)
  • deregulation (remove government restrictions)
• contain aggregate demand in the short term
  • increase money supply which leads to increased total spending and increased price level