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INFLATION

MEASUREMENT IN THE MACROECONOMY. INFLATION. MEASUREMENT IN THE MACROECONOMY. at the end of the lesson you should be able to : Identify the main causes of inflation: Demand pull inflation vs. cost push inflation Excessive growth in money supply Expectations

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INFLATION

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  1. MEASUREMENT IN THE MACROECONOMY INFLATION

  2. MEASUREMENT IN THE MACROECONOMY • at the end of the lesson you should be able to : • Identify the main causes of inflation: • Demand pull inflation vs. cost push inflation • Excessive growth in money supply • Expectations • Interaction of demand pull & cost push inflation

  3. DEMAND-PULL INFLATION Due to the existence of EXCESS DEMAND • Increase in aggregate demand in excess of increase in aggregate supply • at full employment, firms cannot increase production any further. • This excess dd pulls prices up.

  4. DEMAND-PULL INFLATION • Persistent shift of AD curve to the right • associated with the boom cycle of the economy (Yf) when AS is vertical • Main sources of excess AD : - high levels of consumer spending - very fast growth in demand for credit n borrowing - faster rates of economic growth in other countries providing a boost to the economy’s exports

  5. MONETARY INFLATION • According to monetarists , • “inflation is always and everywhere a monetary phenomenon” • Excessive growth in the money supply is inflationary • The monetarists believed in the Quantity Theory of money.

  6. Quantity theory of Money MV = PT • M = amount of money in circulation • V = velocity of circulation • P = general price level • T = no of transactions/GDP • Assume V and T constant, any increase in M will be matched by an increase in P. _ _ MV = PT

  7. Quantity theory of Money • Assume economy can grow only 5% i.e T = 5% • With V and T constant , M must only increase by 5% • If M increases by 8%, then this forces P to increase by 3% • This creates an inflation of 3%

  8. COST-PUSH INFLATION • Due to COST OF PRODUCTION causingleftward shifts of AS • May be the result of rising cost of : • Labour (wages) • Raw materials • Indirect taxes • Imported inputs • Profit motive of firms • Depletion of natural resources

  9. Q2 Cost-push inflation AS2 AS1 Price level P2 P1 AD O Q1 fig National output

  10. Wage push inflation • where Trade Unions increase wages when there is no increase in demand for labour  wage push inflation

  11. Tax push inflation: • Govt increases indirect tax on G&S • or reduces subsidies • thus increasing prices

  12. Imported inflation: Rise in expenditure on imports due to in prices of raw materials, intermediate goods, and final goods imported. e.g.  price of oil import push inflation.

  13. EXPECTATIONS OF INFLATION • Breeds inflation in a self - fulfilling prophecy • Eg. If people expect prices to rise in the near future, they will buy more now than later. • This will create excess demand which is INFLATIONARY!!!

  14. The interaction of demand-pull and cost-push inflation

  15. Subsequent supply response AS AS1 d P3 P2 c b P1 a P0 AD2 AD1 AD Price level O fig National output

  16. e P4 AD3 Subsequent demand response AS AS1 d P3 Price level P2 c b P1 a P0 AD2 AD1 AD O fig National output

  17. AS2 f P5 AS AS1 e P4 Subsequent supply response d P3 Price level P2 c b P1 a P0 AD3 AD2 AD1 AD O fig National output

  18. g P6 AD4 AS2 AS AS1 f P5 e Subsequent demand response P4 d P3 Price level P2 c b P1 a P0 AD3 AD2 AD1 AD O fig National output

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