What inflation means in economics - WITSPOT

What inflation means in economics

                                  MEANING OF INFLATION

       Inflation refers to a persistent and sustainable rise in the general price level. A general phenomenon during a period of inflation is the continuous fall of the value of money in the economy.

       PRICE INDEX

       Changes in the value of money are usually measured through the use of the Index of retail prices. This measures the change from month to month in the average level of prices of the commodities and services purchased by the great majority of households in the given country, including practically all wage-earners and most small and medium salary earners.
      This measurement is sometimes referred to as the cost of living index which indicates what it costs the average family in the country to obtain the necessities of life. A rise in the cost of living index implies a fall in the standard of living of the people in the country and vice-versa.

               TYPES OF INFLATION

Demand-pull inflation
This is the type of inflation that is induced by a
sustained rise in the general price level as a result of a persistent rise in aggregate demand in the economy.

Control of demand-pull inflation
i) Through reduced government expenditure.

(ii) Through increased taxes on income.

(iii) Through increased output.

(iv) Through the price control mechanism.

(V)Through the use of monetary policy instruments
such as the Open Market Operation, Bank Rate,
Cash Ratio, etc.

Cost-push inflation
If the general increase in activity means an increase in the demand for a limited supply of the factors, e.g. raw materials, then shortages develop, labor difficulties tend to rise, cost-push inflation develops, and prices of products rise.
In short, cost-push inflation occurs when an increase in the cost of production is passed on to consumers in the form of high prices.

    General causes of inflation in West African countries.

General causes of inflation include the following:
1) Deficiencies in domestic supply of goods and services: Low domestic output of goods and services are brought about by certain constraints in the economy such as inadequate capital, poor infrastructural facilities, etc.

(ii) Increased incidence of government budget
deficit financing, consequently affecting the
the magnitude of the money supply in the system.

(iii) Low productivity in almost all the sectors of the
economy resulting mostly from very low
capacity utilization especially in the industrial
sector.

iv) Fiscal and monetary policies tend to old hinder rather than encourage domestic production
of goods and services.

(v) Price and income policies which drastically
reduce the purchasing power of the majority of
consumers in the country.

(vi) Poor distribution system which confers undue
advantage on a few who exploit the generality
of consumers in the country.

(vii) Imported inflation arising from indefensible
undervaluation of the national currency.

          EFFECTS OF INFLATION

These include the following:
(i) Increased earnings by businessmen and a
higher level of investment: Businessmen earn
higher profits because of the rising prices of their products, thereby encouraging further investments. Businessmen and investors thus gain in a period of inflation in a country.

(i) Re-distribution of income: People on fixed
incomes such as wage and salary earners suffer
during an inflationary period in an economy.
This is because the value of their real income
falls. There is, therefore, a re-distribution of income in favor of investors;

(iii) Creditors lose while debtors gain: Since the
value of money falls during inflation, creditors
receive less in real terms than what they lent
out, while debtors repay less in real terms;

(iv) Low level of savings and capital formation:
During a period of inflation, people are generally not encouraged to save. This is because they spend more money on goods and services and are afraid that the value of their savings will fall. Capital formation, which depends on savings, is therefore low.

(V) Increased balance of payments difficulties:
Inflation increases the prices of exports relative
to the prices of imports. This would lead to
increased imports and decreased exports With a
consequent worsening effect on the nation’s
balance of payments.

(Vi) Reduced burden of the national debts: The
value of loans taken by the government falls in real
terms in an inflationary period in a country;

(vii) Loss of confidence in the monetary system: Prolonged hyperinflation may lead to loss of confidence in a nation’s monetary unit of account.

        POSITIVE EFFECT OF INFLATION

i) Reduction in the burden of debts as debtors
as gain during inflation.

(ii) Higher prices of commodities encourage higher
output and possibly result in higher profits.

(ii) Higher tax yield of taxes are ad valorem taxes.

(iv) Higher prospects of profit lead to increased
employment of resources and factors.

      NEGATIVE EFFECT OF INFLATION

i) It redistributes income haphazardly. There is a
fall in income especially of those on fixed
incomes e.g. pensioners, poor people, rural
dwellers, etc.

(ii) Creditors lose during inflation.

(iii)Higher prices discourage exports since such countries will be high-cost producers.

(iv) Balance of payments problem arises since foreigners will want to sell to such countries
and do minimal buying from such high-cost
producers.

(v) Inflation discourages savings in the economy.

(vi) It encourages an increase in interest rates.

          CONTROL OF INFLATION

Several measures could be taken to curb inflation.
(i) Price control: This involves fixing maximum
prices on certain essential commodities.

(ii) Wage control: Frequent wage increases should be prevented. Wage control involves the use of an appropriate income policy in which wages are only increased as the level of productivity increases and vice-versa. The Prices, Productivity
font and Incomes Commission implements the wage policy in Nigeria.

(iii) Control of bank lending: Commercial and
merchant banks should be discouraged from granting too many loans (through the use of restrictive monetary policy).

(iv) Sectoral allocation of credit to the more from
productive sectors of the economy: More loans should be directed to the productive sectors of the economy. This would help to increase the output of domestic goods and services and thus reduce their prices.

(V) Use of the budget surplus or reduction in
government expenditure: Government expenditure should be reduced relative to its earned income. This would lead to a reduction in aggregate demand in the economy and thus lead to lower prices.

(vii) Importation of essential commodities: Scarce
but essential commodities could be imported to supplement domestic production and reduce their prices.

(vii) Improving the distributive system: The nation’s
distribution network should be drastically
improved by ensuring efficiency in the
transportation system to prevent unnecessarily
scarcity of commodities.

(ix) The government must as a matter of deliberate
policy, adopt measures that aim at increasing
the supply of factors in the system for increased production of commodities. These measures, if religiously implemented, will bring about a reduction in prices.

(x) Export drive: Government must with the full cooperation of the organized private sector of the economy, engage in a forthright export drive. This would ensure increased foreign exchange earnings for enhanced domestic production and exportation.

Possible solutions to the problems of inflation

(i) Monetary policy-related actions include
mopping up of excess liquidity through open market operations, buying, and selling of securities, use of bank rate, 1Ssuing of directives by the Central Bank, etc.

(ii) Fiscal policy: a general increase in tax and
reduction in government expenditure.

(iii)By increasing production in the economy.

(iv) By reducing bottlenecks in distribution.

(v) By preventing hoarding.

(vi) Through price control and other relevant
legislation.

(vii) Through improved infrastructures such as
log electricity, water, telecommunications, etc.

(viii) Restraint from granting increases in factor
incomes that are not accompanied by increases
in output.

           INFLATION IN NIGERIA
Inflation is a worldwide phenomenon but the rate
varies from country to country. Nigeria has been experiencing a high rate of inflation estimated to be well over 45%. Despite the various measures adopted to control inflation, it has defied solutions.

       Causes of inflation in Nigeria
The causes of inflation in Nigeria are not different
from the ones enumerated in 11.3.4. They include:
(1) Excessive government spending and use of
lo budget-deficit.

(ii) Rapid increases in the cost of production.

(ii)Poor storage facilities.

(iv)Inadequate distributive system.

(V)Low domestic productivity in industry and
agriculture.

(vi)Increases in the prices of imported goods and
to services.

(vii) Frequent wage increase. This leads to excess
demand for certain goods and services.

(viii) Excessive expansion of bank credits.

      Reasons for failure of measures aimed at     controlling inflation in Nigeria:
(i) Difficulty in cutting down government
expenditure due to the increasing demand for
better infrastructural facilities and the need to
create more employment opportunities.

ii)  Ineffective price control due to bribery and
hCorruption, poor transportation facilities, etc.
(iii) Inability to control wages: These result in
frequent industrial actions by workers.

(iv) Poor distributive system which creates
vd bottlenecks in the distribution of goods and
e-services.

(v) Poorly developed money and capital market
which renders the use of monetary policy
ineffective.

(vi) Inability to increase domestic output due to
bottlenecks in production.

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