Inflation Causes Uncertainty For Businesses And Individuals example essay topic

Inflation is the general upward trend in the level of prices. Inflation causes the purchasing power of money to fall. Inflation is categorised in two types being demand-pull inflation and cost-push inflation. One of the main causes of inflation is excess demand.

If demand is growing faster than the level of supply, then prices will increase. Output will increase as well, as there is a shift along the aggregate supply curve, but because supply cannot keep up with demand prices go up as well. Demand-pull inflation will therefore occur in a booming economy. To avoid demand-pull inflation the economy should grow at a steady rate. Cost-push inflation occurs when production costs increase.

To maximise their profit, they need to increase their profit. Therefore cost increases have pushed inflation up. Cost-push inflation occurs because of different factors. Wages are a major part of the production costs and if workers demand a wage rise, firms need to increase prices to prevent form losing from increased production costs and therefore causing inflation. Workers may demand a wage increase because of the expectation theory. (They expect something to happen and act in such a way to cause it to happen.) The value of the Australian dollar compared to other currencies is also an important factor especially if businesses use imports in the production process.

If other countries have high inflation or the Australian dollar is weak, it causes imported inflation. Increase in interest rates can cause inflation if businesses borrowed money to aid production process. If the government change or add extra tax a business may experience increased production costs and it will lead to inflation. (Implementing of GST caused inflation as products are now more expensive. Australia's latest rate of inflation is around 2.9%, while the inflation rate was about 6% when GST was introduced.) The effect of cost-push inflation is to shift the aggregate supply curve to the left. Inflation causes problems for individuals as well as for the whole economy.

Some causes are: The redistribution of income - a great amount of people live on fixed income, especially pension owners. The higher the level of inflation the less their income will be worth. This also happen among working people, as inflation increases faster than their income. Businesses and individuals would have to face inconvenient costs such as extra administrative work, redo their supply lists, price lists, business and individual budgets etc. Inflation will cause Australia to be less competitive in the export market. If inflation causes prices to be very high, other countries wouldn't compete with Australia causing our goods to be less in demand.

This is very important because the export market is very important to the Australian economy. Inflation causes uncertainty for businesses and individuals. Uncertainty causes slower or negative economic growth because business and consumer confidence decrease. (This was recently seen because of 9/11) Stagflation is a term used when an economy experience high levels of inflation and unemployment and generally decreased economic growth. Stagflation is caused by the primary factors of cost-push inflation. The monetarist theory is that growth in money supply without equal growth in production will cause inflation.

Meaning the government cannot print money to increase money supply as it will only cause inflation because their will be more money physically but the same amount of purchasing power. Low levels of inflation are always desirable as it is associated with increased economic growth. Therefore price stability is one of the government's main macroeconomic objectives. The government strives to achieve zero inflation or an acceptable rate of inflation. Australia has an income policy which is says that wage adjustments are based on the efficiency and productivity of a worker to prevent unnecessary wage increases which causes inflation. The CPI measures the inflation rate.

They purchase a basket of consumer goods and services over a three-month period. This basket exists of a wide range of goods and services. They use metropolitan wages and salaries. The goods and services from the basket is selected from eight major groups. (Food, clothing, housing, household equipment, transportation, entertainment, tobacco and alcohol, health, education.) These groups are reviewed each quarter to stay up to date with consumer preference.

Accurate prices are then collected from all kinds of retail outlets in metropolitan areas. Goods like fruits and vegetables are seasonally adjusted to ensure accurate prices. All items are weighted in accordance to importance to consumers. For example bread and milk is weighted more important than a delicacy like oysters.

Comparison to the base year is then made with goods and services form the base year valued at a 100. The CPI is limited and reflects prices of only a handful of goods and services. The CPI is taken only every 3 months and therefore data may not be relevant or up to date. Price increases may be because of improvements and not necessarily from inflation. Some individuals or businesses may be winners of inflation. Borrowers are winners as the money the borrowed has greater purchasing power as the money they are repaying, fortunately interest rates compensate for it.

Skilled workers will be able to bargain a pay rise to prevent from losing from inflation. Real asset holders win such as people owning rare artwork. Organised businesses and individuals will shift from monetary to real assets. Workers belonging to a union, they are able to get a pay rise. Monopolists who can make the prices. The government can increases taxation to prevent from losing from inflation.

Some individuals and businesses are lose because of inflation. Consumers lose as the purchasing power of their money decrease. Lenders of money lose as they are repaid with money that are less worth than what the lent. Savers lose because the money have less purchasing power in the future. People of fixed incomes don't get wage increases and when they do get increases, inflation may have increased even more. Businesses known as price takers participating in a perfect competition or monopolistic market.

High income earner will be pushed into a higher tax bracket causing them to pay more tax. Inflation if overly negative for an economy and therefore is price stability such and important objective to the Australian economy..