Inflation and Deflation

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Welcome to class! 

In today’s class, we will be talking about inflation and deflation. Enjoy the class!

Inflation and Deflation

CONTENT

1. Meaning, Types, Causes of Inflation
2. Effects and Controls
3. Deflation, Meaning and Causes
4. Effects and Controls
5. Terminologies Associated with Inflation

INFLATION

It is a persistent rise in the general level of price of goods and services.  Inflation occurs when there is an increase in the money supply without a corresponding increase in the volume of production.

TYPES OF INFLATION

1. Demand-Pull Inflation
2. Cost-Push Inflation
3. Hyper-Inflation
4. Creeping Inflation

Demand-Pull Inflation – This occurs when there is excess demand for goods and services over the supply.  The factors responsible for this type of inflation may be due to population increase, increase in workers’ salaries and wages, etc.

Cost-push Inflation – Producers pay for factors of production, any slight increase in the price of factor input will reflect in the price per unit.  For example: if there is an increase in the price of flour, sugar, butter, automatically the price of bread would be high.

Hyper- Inflation – This occurs when the prices of goods and services are rising fast to the extent that money is losing its value or its ability to buy goods.  War, budget deficits, etc. are the major causes of hyperinflation.  Hyperinflation is also known as – galloping inflation or runaway inflation.

Creeping Inflation – This type of inflation occurs when there is a slow but steady rise in the general prices of goods and services.  It is also known as persistent inflation

EVALUATION

1. What is inflation?
2. Mention four types of inflation you know.

CAUSES OF INFLATION

1. Inflation occurs when there is excess demand for goods and services e.g. demand-pull inflation.
2. Low productivity e.g. agriculture;
3. Increase in salaries and wages.
4. The high cost of production.
5. Budget deficit i.e. when government expenditure is more than its income.
6. Inflation can also be caused if there is an increase in population that will force demand to rise.
7. Excessive bank lending.
8. The high cost of importing raw material can lead to a high cost of goods.
9. Hoarding – which is an act of creating artificial scarcity.
10. Inflation can be caused due to industrial action by workers e.g. strike, tools down etc.
11. Poor storage facilities.
12. Money laundering – which is mass transfer and injection of money into circulation.

EFFECTS OF INFLATION

Inflation as a phenomenon is a necessary evil.  In other words, it has positive and negative effects in the overall economy.

POSITIVE EFFECTS OF INFLATION

1. During inflation, the debtor gains at the expense of the creditor.
2. Inflation period serves as a period where businessmen make a profit.
3. Inflation stimulates investment.
4. The employment rate is high during inflation.
5. Due to the second, third and fourth points stated above, inflation helps the economy to grow.

NEGATIVE EFFECTS OF INFLATION

1. The lenders (creditors) incur a loss because the money loses its value as inflation persists.
2. Distortion in the economy due to agitation for an increase in wages and salaries.
3. Fixed income earners e.g. salary earners suffer a lot during inflation.
4. Money loses its value during inflation.
5. It leads to a balance of payment problems.
6. Inflation discourages savings since money loses its value day in day out.
7. Fall in the living standard of the people.

EVALUATION

1. State four positive effects of inflation.
2. State five causes of inflation

HOW TO CONTROL INFLATION

1. In an attempt to stem inflation, the government should encourage industrialization to make goods and services available.
2. Where inflation is triggered by an increase in money supply, the effective interest rate could be adopted i.e. increasing the interest rate to discourage excessive borrowing.
3. Effective use of fiscal policy e.g. Taxation as a way of reducing the disposable income of workers can help to check inflation.
4. Removal of bottlenecks in the distribution system. This will enhance free flow of goods.
5. Legislation could be put in place to check the activities of hoarders.
6. Contractionary monetary policy can also help to check inflation where inflation is caused by an increase in the money supply.
7. Subsidies – for farmers, business, will help in solving the problem of increase in the prices of inputs e.g. hoe, cutlass.
8. Wage freezing i.e. government should not increase salaries.

EVALUATION

1. Describe the effects of inflation on the economy of a country.
2. What efforts has the government of Nigeria made to combat inflation?

TERMINOLOGIES ASSOCIATED WITH INFLATION

1. INFLATION GAP – This is an economic situation in which the total demand in the economy exceeds the total supply of goods and services available to satisfy demand. To arrive at this, subtract the total amount of money available for spending from the total money value of the actual good and services available to meet the demand.
2. INFLATION SPIRAL – A price increase will make workers demand an increase in income (wages and salaries). This will cause a rise in the general level of price.  This is known as the inflation spiral.
3. DISINFLATION – The direct control of consumer’s expenditure as a way of checking inflation is known as disinflation. This is done by reducing the supply of money and increasing interest rates etc.
4. REFLATION – This refers to the economic state of affairs in which prices, employment, output etc. is picking up again as a result of conscious government policy to that effect.
5. STAGFLATION – When a high rate of inflation exists at the same time as industrial production is slowing down, then we refer to this as stagflation.
6. SLUMPFLATION –  Slumpflation occurs when the economic condition in which much reduced economic activity co-exists with inflation.

DEFLATION

It  is defined as a persistent fall in the general level of price. This is a situation where the volume of money in circulation is not sufficient to meet up with the prevailing economic situation. This is a direct opposite of inflation.  This is a fall in the general level of price as a result of a decrease in the volume of money in circulation.

CAUSES OF DEFLATION

1. Deflation is caused by the failure of the government to spend i.e. Budget surplus.
2. When banks increase their interest rate, it discourages borrowing as such money supply drops. This amounts to deflation.
3. Where the productivity exceeds the demand coupled with a decrease in money supply then deflation sets in.
4. Where workers are excessively taxed leaving them with little disposable income, their marginal propensity to consume drops thereby leading to deflation.

EVALUATION

1. Write a short note on; (a) inflation gap (b) stagflation (c) deflation
2. State four causes of deflation.

 

In our next class, we will be talking about Public Finance.  We hope you enjoyed the class.

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