Faculty of Tourism and Hotel Management

Inflation
Under the course of Economics

Prepared for: Dr. Fatten Mohammad

Prepared by : Yara Hossam Hassan
Hotel Management Department

Table of Contents

Introduction to Economics -3
Introduction to Inflation - 4
Causes - 5
Types - 6
Effects - 7
Advantages - 8
Disadvantages - 9
Cures - 10
Appendix -11
References- 12

Introdu
ction to Economics

conomics has been called The Dismal Science. But it's also called
the science of how people get a living. Our daily lives are beset with
economic questions! Why is it so hard to buy a home? Why does the
cost of college rise so fast? Why are willing, able workers unable to find jobs?
What about us, the voting citizens is basic economic literacy out of our
reach?
We are told, we need to ask the experts. But the experts tell us, Its more
complicated than that! Referring to obscure formulas and charts, they pitch
their arguments at each other.
Economics is the study of the production and consumption of goods and
the transfer of wealth to produce and obtain those goods. Economics
explains how people interact within markets to get what they want or
accomplish certain goals. Since economics is a driving force of human
interaction, studying it often reveals why people and governments behave in
particular ways. It is also the study of how people choose to use resources.
Resources include the time and talent people have available, the land,
buildings, equipment, and other tools on hand, and the knowledge of how to
combine them to create useful products and services. Important choices
involve how much time to devote to work, to school, and to leisure, how
many dollars to spend and how many to save, how to combine resources to
produce goods and services, and how to vote and shape the level of taxes
and the role of government. Often, people appear to use their resources to
improve their well-being. Well-being includes the satisfaction people gain
from the products and services they choose to consume, from their time
spent in leisure and with family and community as well as in jobs, and the
security and services provided by effective governments. Sometimes,
however, people appear to use their resources in ways that don't improve
their well-being.
A study of economics can describe all aspects of a countrys economy,
such as how a country uses its resources, how much time laborers devote to
work and leisure, the outcome of investing in industries or financial
products, the effect of taxes on a population, and why businesses succeed or
fail.

People who study economics are called economists. Economists seek to

answer important questions about how people, industries, and countries can
maximize their productivity, create wealth, and maintain financial stability.
Because the study of economics encompasses many factors that interact in
complex ways, economists have different theories as to how people and
governments should behave within markets. Economists seek to measure
well-being, to learn how well-being may increase over time, and to evaluate
the well-being of the rich and the poor.

There are two main types of economics:-Macroeconomics and

microeconomics, Microeconomics focuses on the actions of individuals and
industries, like the dynamics between buyers and sellers, borrowers and
lenders. Macroeconomics, on the other hand, takes a much broader view by
analyzing the economic activity of an entire country or the international
marketplace. In short, economics includes the study of labor, land, and
investments, of money, income, and production, and of taxes and
government expenditures.

In
troduction to Inflation

n economics Inflation is term that is used to describe the general

increase in the prices of commodity and services in an economy
over a certain period of time. It is described as an index because
the current prices of commodities are compared to a standard
prices level. The effect of general increase in price of commodity is the
loss of the money purchasing power. Inflation is used to measure the
purchasing power of a unit of currency. Inflation can be measured by a
lot of indexes the main measure of prices is the price index. Price index
is also referred by some economists as the consumers price index. It
considers the most common goods and services in the economy like
the prices of foodstuffs, housing prices and the cost of medical care in
an economy. Price changes occur in both directions, price change can
either be negative or positive. Negative price changes indicate that
there is deflation and an increase indicates that there is inflation. The
word inflation has always been associated with negative results but
there are positive results brought about by inflation. It is known in

economy that a mild inflation has to exist in the economy for economic
growth to take place.
Negative results of inflation will start to be felt when the central bank
in a country is unable to maintain the inflation at the mild stages.
Some of the negative results associated with high inflation are
decrease in the real money value, future uncertainty on saving and
investments, adverse effect of inflation are shortages of commodities
as businessmen hoard the goods in anticipation that the prices will
push upwards further. Other effects of inflation are that it lowers the
standards of living for the citizen of a country. Inflation will also favor
some businessmen in an economy and will be making abnormal profit
during this period this will lead to uneven distribution of wealth in an
economy. The other positive results of inflation apart from enhancing
economic growth is that it can be used by the central bank in time
of recession by adjusting the nominal rates to promote growth.
Inflation can also to encourage investment on non monetary long term
project because such projects will not be affected by changes in prices
and hence are cushioned from the effects of inflation.
Inflation is mostly grouped into four main categories based on the
percentage of inflation. The categories are: Creeping inflation,
moderate inflation, rapid inflation and hyperinflation. Creeping inflation
occurs when the prices of commodities rises by about 2% to 3% .This
type of inflation will induce investment hence it good for the economy.
Moderate inflation will be felt when prices of commodities rise by 4% to
5% it might be harmful if nit checked. Rapid inflation occurs if prices
rise by over 6% and will harm the economy. The last one is the
hyperinflation or galloping inflation. When this occurs the country will
be said to have failed economically. Inflation can be controlled through
monetary and fiscal policy.

Causes of Inflation
The main causes of inflation are either excess aggregate demand
(economic growth too fast) or cost push factors (supply side factors)
Demand pull inflation If the economy is at or close to full
employment then an increase in AD leads to an increase in the price
level. As firms reach full capacity, they respond by putting up prices,
leading to inflation. Also, near full employment, workers can get higher
wages which increases their spending power.
Cost Push Inflation If there is an increase in the costs of firms, then
firms will pass this on to consumers. There will be a shift to the left in
the AS.
Rising wages If trades unions can present a common front then they
can bargain for higher wages. Rising wages are a key cause of cost
push inflation because wages are the most significant cost for many
firms. (higher wages may also contribute to rising demand)
Raw Material Prices The best example is the price of oil, if the oil
price increase by 20% then this will have a significant impact on most
goods in the economy and this will lead to cost push inflation.
Profit Push Inflation When firms push up prices to get higher rates of
inflation. This is more likely to occur during strong economic growth.
Declining productivity If firms become less productive and allow
costs to rise, this invariably leads to higher prices.
Higher taxes If the government put up taxes, such as VAT and Excise
duty, this will lead to higher prices, and therefore CPI will increase.
However, these tax rises are likely to be one-off increases. There is
even a measure of inflation (CPI-CT) which ignores the effect of
temporary tax rises/decreases.
What else could cause inflation?
Rising house prices Rising house prices do not directly cause
inflation, but they can cause a positive wealth effect and encourage
consumer led economic growth. This can indirectly cause demand pull
inflation
Printing more money If the Central Bank prints more money, you
would expect to see a rise in inflation. This is because the money
supply plays an important role in determining prices. If there is more
money chasing the same amount of goods, then prices will rise.
Hyperinflation is usually caused by an extreme increase in the money
supply

However, in exceptional circumstances such as liquidity trap /

recession, it is possible to increase the money supply without causing
inflation. This is because in recession, an increase in the money supply
may just be saved, e.g. banks dont increase lending but just keep
more bank reserves.

Types of inflation
Different types of inflations can have widely different determinants,
effects and remedies. There is no strictly binding definition of ranges of
intensity in price increase. Still, some indications can be given as it
follows:Hyperinflation is the most extreme inflation phenomenon, with yearly
price increases of three-digit percentage points and an explosive
acceleration.
Extremely high inflation could range anywhere between 50% and
100%. High inflations a situation of price increase of, say, 30%-50% a
year. Both kinds can be stable or dangerously accelerate to enter in an
hyperinflation condition.
Moderate inflation can be differently defined around the world, given
the different inflation histories. As an indication only, one could
consider an inflation as moderate when it ranges from 5% to 25-30%.
For some countries, the higher part of this range is already "high
inflation".
Low inflation can be characterized from 1-2% to 5%. Around zero
there is no inflation (price stability). Below zero, a country
faces deflation.
Demand-Pull Inflation This occurs when AD (aggregate demand)
increases at a faster rate than AS (aggregate supply). Demand pull
inflation will typically occur when the economy is growing faster than
the long run trend rate of growth. If demand exceeds supply, firms will
respond by pushing up prices.

Cost Push Inflation This occurs when there is an increase in the cost
of production for firms causing aggregate supply to shift to the left.
Cost push inflation could be caused by rising energy and commodity
prices.
Wage Push Inflation Rising wages tend to cause inflation. In effect
this is a combination of demand pull and cost push inflation. Rising
wages increase cost for firms and so these are passed onto consumers
in the form of higher prices. Also rising wages give consumers greater
disposable income and therefore cause increased consumption and AD.
Imported Inflation Depreciation in the exchange rate will make
imports more expensive. Therefore, the prices will increase solely due
to this exchange rate effect. A depreciation will also make exports
more competitive so will increase demand.
Transversal classification distinguishes inflations, basing on their
broadly-defined origins:
1. Domestic demand
2. Domestic costs; as wages
3. External sources; as oil price increases or currency relative
devaluation.

A systematic institutional difference is between countries having or not

having (partial or total) indexation of wages (and other income
sources).
Indexation makes inflation much less painful, but normally keeps it at a
higher level and increases the risk of a continuous acceleration.

Effects of Inflation
The Redistribution of Income and Wealth; Unanticipated inflation,
inflation that is not expected, will redistribute income and wealth.
Redistribution of income occurs because some wages and salaries
increase more rapidly than the price level while other wages and
salaries increase more slowly than the price level. Redistribution of
wealth occurs because some asset prices increase more rapidly than

the price level while other asset prices increase more slowly than the
price level. An important redistribution of income and wealth that
occurs during unanticipated inflation is the redistribution between
debtors and creditors. Debtors gain from inflation because they repay
creditors with dollars that are worth less in terms of purchasing power.
Anticipated inflation; inflation that is expected, results in a much
smaller redistribution of income and wealth. Unanticipated inflation
benefits government because government gains tax revenue as
nominal income increases. The increase' in nominal income pushes
people into higher tax brackets. To prevent this redistribution of
income, the personal income tax system is now indexed; however, the
rest of the federal tax system is not. Some argue that the benefits of
inflation decrease government's incentive to vigorously pursue antiinflationary policies.
Inflation and Net Exports: Unanticipated inflation can cause net
exports to fall. Inflation makes goods produced in the United States
relatively more expensive, resulting in a decrease in exports. Inflation
makes goods produced abroad relatively less expensive, resulting in
an increase in imports
Other Effects: As the inflation rate increases and becomes more
variable, more resources may be devoted to predicting inflation and
fewer devoted to the production of goods and services. . Firms may
concentrate on short-term projects rather than long-term projects.
There may be speculation in real estate, gold, and art, causing funds
to flow away from investment in plant and equipment. The nation's
monetary system may disintegrate.

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Advantages of Inflation
Deflation (a fall in prices negative inflation) is very harmful.
During a prolonged period of deflation and very low inflation, the
Japanese economy has suffered lower growth because of deflationary
pressures. When prices are falling people are reluctant to spend
money because they are concerned that prices will be cheaper in the
future, therefore, they keep delaying purchases. Also, deflation
increases the real value of debt and reduces the disposable income of
individuals who are struggling to pay off their debt. When people take
on a debt like a mortgage, they generally expect an inflation rate of
2% to help erode the value of debt over time. If this inflation rate of
2% fails to materialize, their debt burden will be greater than
expected.
Moderate inflation enables adjustment of wages. It is argued a
moderate rate of inflation makes it easier to adjust relative wages. For
example, it may be difficult to cut nominal wages (workers resent and
resist nominal wage cut). But, if average wages are rising due to
moderate inflation, it is easier to increase the wages of productive
workers wages; unproductive workers can have their wages frozen
which is effectively a real wage cut. If we had zero inflation, we could
end up with more real wage unemployment, with firms unable to cut
wages to attract workers.
Inflation enables adjustment of relative prices. Similar to the
last point, moderate inflation makes it easier to adjust relative prices.
This is particularly important for a single currency like the Eurozone.
Southern European countries like Italy, Spain and Greece became
uncompetitive, leading to large current account deficit. Because Spain
and Greece cannot devalue in the Single Currency, they have to cut
relative prices to regain competitiveness. With very low inflation in
Europe, this means they have to cut prices and cut wages which
causes lower growth (due to effects of deflation). If the Eurozone had
moderate inflation, it would be easier for southern Europe to adjust
and regain competitive without resort to deflation.
Inflation can boost growth. At times of very low inflation the
economy may be stuck in a recession. Arguably targeting a higher
rate of inflation can enable a boost in economic growth. This view is
controversial. Not all economists would support targeting a higher
inflation rate. However, some would target higher inflation, if the
economy was stuck in a prolonged recession.

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Disadvantages of Inflation
Inflation is usually considered to be a problem when the inflation rate
rises above 2%. The higher the inflation, the more serious the
problem it is. In extreme circumstances hyper inflation can wipe away
peoples savings and cause great instability, e.g. Germany 1920s,
Hungary 1940s, Zimbabwe 200s. However, in a modern economy, this
kind of hyper inflation is rare. Usually inflation is accompanied with
higher interest rates so savers do not see their savings wiped away.
However, inflation can still cause problems.
Inflationary growth tends to be unsustainable leading to a
damaging period of boom and bust economic cycles. For example, the
UK saw high inflation in the late 1980s, but this economic boom was
unsustainable and when the government tried to reduce inflation, it
led to the recession of 1990-92.
Inflation tends to discourage investment and long term
economic growth. This is because of the uncertainty and confusion
that is more likely to occur during periods of high inflation. Low
inflation is said to encourage greater stability and encourage firms to
take risks and invest.
Inflation can make an economy uncompetitive. For example, a
relatively higher rate of inflation in Italy can make Italian exports
uncompetitive, leading to lower AD, a current account deficit and
lower economic growth. This is particularly important for countries in
the Euro-zone because they cant devalue to restore competitiveness.
Reduce value of savings Inflation leads to a fall in the value of
money. This makes savers worse off If inflation is higher than
interest rates. High inflation can lead to a redistribution of income in
society. Often it is pensioners who lose out most from inflation. This is
particularly a problem if inflation is high and interest rates low.
Menu costs costs of changing prices lists which becomes more
frequent during high inflation. Not so significant with modern
technology.

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Cures of Inflation

Reducing aggregate demand

Tightening fiscal policy Basically, this involves reducing
government spending and/or increasing taxation. Reducing
government spending directly shifts the AD curve to the left, and
increases in taxation do the same, but indirectly, through the
reduction of consumers' disposable income, which leads to, reduced
consumer spending.
Tightening monetary policy Today this means increasing interest
rates, which makes it more expensive for firms to invest and
consumers to borrow and spend. Also, consumers mortgage payments
rise, which leaves them less disposable income to spend. But as we
have seen, the control of the money supply and the level of the
exchange rate are linked. Governments can usually only control one of
these three things at once (although some would say it is impossible
to control the money supply). Higher interest rates tend to push the
value of the uro up anyway, which helps keeps the price of imports
down.
Reducing aggregate supply
Incomes policies You will never hear a politician utter these words.
Basically it involves controlling wage rises and so stopping the AS
curve from shifting further to the left. This will make cost-push
inflation less likely. This was used often in the 70s following the union
inspired wage-price spirals. It was not very popular! This is obviously
not something that monetarist economists (who like free markets)
believe in, as it disrupts the free working of labor markets. Having
said that, the last Conservative government did operate a pay freeze
in the public sector (they have no control over the private sector,
obviously). Of course, they didn't dare refer to it as an 'incomes
policy'!
Improving the supply side ways in which the long run aggregate
supply curve could shift to the right, increasing the productive
potential of the economy and reducing the price level for a given
aggregate demand curve (assuming the LRAS curve is vertical).

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Policies included improved education and training, privatization and

deregulation, control of the trade unions, increasing the flexibility of
the labor market and incentives for firms to invest.

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Appendix

WORLD INFLATION RATE,2010 By TomBrauer (Own work) [CC BY-SA 3.0

(http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons

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References:
http://www.economicshelp.org/blog/315/inflation/inflation-advantages-anddisadvantages/

https://www.bostonfed.org/economic/nerr/rr1997/winter/hell9
7_1.htm
http://www.whatiseconomics.org/macroeconomics/inflationand-deflation
https://www.aeaweb.org/students/WhatIsEconomics.php
http://www.whatiseconomics.org/
http://www.economicshelp.org/blog/2656/inflation/different-types-of-inflation/
http://www.economicswebinstitute.org/glossary/inflat.htm
https://www3.nd.edu/~cwilber/econ504/504book/outln13c.html
http://www.henrygeorge.org/econ
The Investor's Guide to Technical Analysis By C. Colburn Hardy
Inflation: Causes and Effects by Robert E. Hall