INFLATION AND DEFLATION
Inflation is the continuous and persistence rose in the general price level of goods and services. It is a reduction in the purchasing power of money. It is a period characterized with too much money purchase few goods. Therefore, the purchasing power and general price levels varies inversely with each other. Inflation can be ordinary or hyper. It is hyper when there is sky rocketing of prices of goods and services.
TYPES OF INFLATION
Cost push inflation: This is due to an increase in the cost of acquiring factor inputs. It may occur in an economy when increases in the cost of production are passed on to the final consumer in form of high prices. Here, cost if producing goods increases faster than productivity. An example of high cost of production is wages.
Demand pull inflation: This is a kind of inflation where high level of demand leads to demand of goods and ultimately increase in prices. The aggregate demand is increasing while aggregate supply is constant. When this happens, price of goods will increase.
Hyper inflation: This means that prices are sky rocketing with little or no increase in output. It occurs when the rate of inflation is very high and is out of control. The rate of inflation is not measurable because prices rise rapidly within a day. Hyper inflation is extremely rapid inflation in which prices increases so fast that money loses its function as a medium of exchange. It is also called galloping inflation.
Creeping inflation: This a type of inflation in which there is a slow but continuous upward movement in the general price level if goods over the years. Creeping inflation increases persistently and continuously over a time. It increases in an average level of 3% annually.
Causes of Inflation
Poor storage facilities: Lack of adequate storage facilities can affects prices of goods and cause inflation. This is because goods that are not properly stored will get spilt, thereby reducing supply. When demands outstrips supply, prices of goods will rise up.
Increase in Wages and Salaries: When wages and salaries are increases there is increase in the purchasing power of workers. Too much money therefore, will be purchasing few goods thereby leading to inflation.
Increase in population: When there is increase in the population size of a country, it leads to increase in the demand for goods thereby leading to inflation.
Increase in cost of production: Increase in cost of factor inputs also increases there price of goods. The producer will pass the increase in cost of production to consumers in form of high prices.
Reluctant on importation: When an economy relies too much on imports, increases in prices in any of the producing country will lead to increase in prices in the country importing. Also, there if there is increase in the cost of raw materials imported , price will increase
Other causes of inflation are low productivity in industrial sector, poor distribution system, increase in government expenditure, war and strive and increase in demand.
Measurement of Inflation
Wholesale price index: This measures the prices of factors inputs like equipment, machinery and raw materials used for productive activities. Increase in prices of these inputs will affect the price of goods and services.
GDP Deflator: GDP index measures the behaviour of prices of domestic goods and services. It is an index of price changes of goods and services. It is calculated by dividing GDP at current price with real GDP (at constant prices.
Formula = Nominal GDP/Real GDP X 100
Consumer price Index: This measures changes in the prices of goods and services which are used for consumption. It measures changes in the standard of living of the populace.
CPI = Current year price index/ Base year price index X 100
Positive Effects of Inflation
Increase in price of goods leads to higher profit to the producers and this increases the level of investment
Higher prices encourage the producers to produce more and increase the output which satisfy the law of supply
It increases the profit margin of producers as they produce and sell more at higher prices.
It increases the tax yield of the government collected from consumers income and commodities e.g ad valorem tax
Borrowers gain during inflation because the value of money is less compared to when it was borrowed as they pay less in real term
Reduction in the burden of national debt decreases when prices are rising
Negative Effects of Inflation column
It reduces the marginal propensity to save because more money purchases fewer goods
It leads to efficient resources allocation as scarce resources are diverted to goods which have higher prices
Since the value of money is lost, the people cannot afford the good things of life that bring comfort. Hence, the standard of living falls
The fixed income earners are affected because there is a fall in the real value of their income
It reduces the volume of production because of increases in the cost of factor inputs
Creditors are badly age red during inflationary period as they receive less in terms of real value for their money
It reduces the value of domestic currency
Control of Inflation
The government may increase the tax to reduce the amount of money in circulations to cut personal consumption expenditure
Government should reduce their unnecessary expenditure on non-developmetal projects to reduce money in circulations
Maximum prices can be fixed for essential commodities to ensure fair distribution of scarce goods
Production of essential goods/commodities should be encourage to curb rising prices
Subsidies should be granted to companies producing essential commodities to reduce the cost of production and the prices of such goods
Monetary policy measures to stabilize the exchange rate of the currency should be put into consideration
There should be reduction in the deficit budgeting. That is, surplus budget should be adopted to curb inflation
Causes of Inflation in Nigeria
Increase in Wages and salaries with no increase in production of goods/essential commodities
Introduction of higher denomination of naira like #1000, #500 and #200 in recent years
Removal of petroleum subsidies which has increase the cost of transportation
Continuous budget deficit which is always go danced by money borrowed internally or externally
Smuggling of goods to other country to earn foreign currencies which reduces goods for domestic consumption
The level of productivity is very low and this has reduced the level of output in Nigeria
Excessive supply of money in circulation which leads to increase in aggregate demand for goods which will ultimately lead to price increase
Concepts Related to Inflation
Inflationary gap: This occurs when aggregate demand exceeds aggregate supply of output at full employment. Demand is higher relative to output
Disinflation : This is a policy measure adopted by the government to reduce prices deliberately but leaves output and employment the same. It is designed to maintain the value of money
Stumpflation: This refers to a situation whereby a period of abnormal low economic activity and unemployment exists with rising price of goods. Resources are underutilized and price of goods increases
Stagflation: This is used to describe a situation whereby the economy is experiencing a high rate of inflation and recession. It is a period where a country persistently suffers both high inflation and unemployment
Open inflation: This is a type of inflation which comes about as a result of uninterrupted operation of the market system. When there is increase demand and shortage join supply open inflation occurs.
Suppressed inflation: This occurs when the market is not allowed to function freely. Some controls like price control and rationing have been used by the government to check open inflation
Imported inflation: This occurs when raw materials and component of goods are imported at high prices and this will affects the price of domestic goods
Reflation: This is the easing of credit restriction to encourage an expansion of production. Prices and outputs are raised deliberately by the government to encourage economic activities
This is a continuous fall in the general price level of goods and services. It is a progressive reduction in the general price level of goods and services. During deflation , there is a rise in the purchasing power of money
Causes of Deflation
Budget surplus: When the expenditure off the government reduces the money in circulation also reduces and thereby prices of goods fall
Increase in bank rates: This reduce their lending capacity of he commercial bank and thereby reduce the money in circulations
Excess supply over demand: During deflation, the producers are forced to dispose of their goods as the price falls
I crease in taxation: Of there is increase in taxes, it will redo e the disposable I come of the consumers and therefore demand for goods is reduced to encourage decrease in prices of goods
Increase in production: If the output is increased and it’s not matched with corresponding increase in the value of money in circulation deflation will occur in the economy
Effects of Deflation
Fixed Income Earners Gain: Pensioners and salary workers gain at the expense of people without fixed income because the value of money roses with falling prices
Lenders Gain: Lenders going because the value of money being repaid is more than the original amount sent out to borrowers
Reduction in production: Since there is reduction in prices of goods , producers produce less
Reduction in profits Profit if the producer is reduced because prices of goods fall faster than the cost of factor inputs
Increased in value of money: There is increase in the purchasing power of money as money will buy more goods at deflationary periods
Fall in prices of goods: Deflation is a continuous decrease in the general price level of goods and services
Other effects of Deflation are reduction in national output and employment, discourages importation Increase in burden of public debt, decrease in investments, and encourages export of goods
Controls of Deflation
Reduction in taxes: This is a fiscal policy the government will implement to increase disposable Income. Reduction in taxes will increase the consumption ability of the consumers. By reducing taxes on corporate profits more money will be available for investment
Introduction of expansionary monetary policy: The government can embark on expansionary monetary policy by increasing the reserves of the commercial banks by reducing the interest rate and by buying securities in the market.
Increase in public expenditure: This will increase aggregate demand for goods and services . There will be more money in circulation.
Deficit budget: To curb deflation the government should adopt the policy of deficit budgeting. Expenditure on amenities that will stimulate and create demand for commodities should be encouraged
Increased in Wages and salaries: This is done to I crease the purchasing power of consumers and ultimately increase the volume of money in circulation. Increase in Wages and salaries will stimulate demand for goods