ECONOMICS TOPIC: INFLATION

We will look at : Definition of inflation Types of inflation Causes of inflation Cost of inflation Rate of inflation in Bangladesh

What is inflation: Inflation is the persistent and generalized rise in price level for a particular time. During inflation purchasing power of money falls and real income drops down.

INFLATION AND BANGLADESH The latest inflation rate Bangladesh has been 9.4% (2008 est.)according to CIA world fact book. .

Types of Inflation Creeping Inflation Galloping Inflation Hyper Inflation Stagflation Suppressed Inflation

Degrees of Inflation Rate of inflation Outcome Creeping inflation <4% Very mild inflation which might bring competitiveness Mild inflation 4%-10% Mild inflation which must be kept under control to avoid future difficulties. Inflationary pressure 10%-20% Inflationary pressures builds up with high wage demands and interest rates. Savings begins to be affected. Strict policies are essential. Severe inflation 20%-50% Serious inflation. Confidence in money eroded. Hyper inflation 50%+ Signs of hyper inflation. Domestic economy collapses, currency becomes worthless internally or in international FC market.

Creeping Inflation It is a slow rate of inflation where price increases at a rate of 0-4%. Here price increases slowly so it don’t hurt the customers but increases the profit of the manufacturer. Therefore, investment, employment, output, and economic growth increases. Galloping Inflation This is a faster rate of inflation. Here, price increases at a rate of 5-100%. Here, price increases sharply and people loss their purchasing power. Therefore, demand fall, lead to fall in investment , employment , output and economic growth. Hyper Inflation This is a very high rate of inflation. Here, price increases at a rate of more than 100%. Here, price increases sharply and people loss their purchasing power. Therefore, demand fall. further investment , employment , output and economic growth falls. Suppressed Inflation It occurs when market inflation shows less then the actual due to government measures. If government takes off the measures, inflation will further increase. Stagflation a relatively recent phenomenon in the economy of the 1970s is what is called ‘Stagflation or Slumpflation’ . It is the worse condition for an economy when both inflation and unemployment increases at the same time.

An index number deals with percentage changes. Retail Price Index Retail price index is measure of changes in the prices of consumer goods and services bought by people. An index number deals with percentage changes. An index of prices is an average of the percentage changes in the prices of a number of goods and services

Example Year 1 Commodity Weight Price Index A 1 Tk 10 100 B 2 Tk 100 C Weighted index A 1 Tk 10 100 B 2 Tk 100 200 C 3 Tk 500 300 =6 =600/6 RPI=100 Year2 Tk12 120 Tk 150 150 Tk 450 90 270 690/6 RPI=115 Rate of inflation 15 % Change in index =y2-y1/y1 X 100+100

Retail Price Index If the index is calculated to be over 100 in year 2, then the cost of living has increased compared with the base date, year 1. for example, if the index is 115, then the cost of living has increased by 5 percent since the base year. An index of below 100 in year 2 would indicate a fall in the cost of living. The change in the cost of living index is usually measured in nominal terms, which are in terms of the prices operating in the year in which the goods are produced.

INCREASE IN MONEY SUPPLY CAUSES OF INFLATION DEMAND PULL INFLATION COST PUSH INFLATION INCREASE IN MONEY SUPPLY

Cost-push inflation Price level P1 O Q1 National output AS2 AS1 An increase in wages, increase in import prices or an increase in indirect taxation may raise the cost of factors of production. It causes a leftward shift to the aggregate supply curve and price level is ‘pushed up’. Price level P1 AD O Q1 National output

Cost-push inflation Price level P2 P1 O Q2 Q1 National output AS2 AS1 An increase in wages, increase in import prices or an increase in indirect taxation may raise the cost of factors of production. It causes a leftward shift to the aggregate supply curve and price level is ‘pushed up’. Price level P2 Q2 P1 AD O Q1 National output

MONEY SUPPLY When the government increases the supply of money inside a country the value of that country's currency also decreases locally and internationally. p1 p2 Q1 Q2

Causes of Inflation in Bangladesh Excess population demands more goods and services every year. Thus demand pull inflation takes place. Dependency on imported products and syndicate of importers also causes prices to rise and Cost push inflation occurs. Good amount of foreign aid and overseas loans from international financial institutions increases the supply of money and causes high inflation.

DEMERITS OF INFLATION Social cost: during inflation fixed income group cannot consume sufficient goods and services. Therefore, they become highly annoyed with government and it creates social and political costs. Shoes and lather cost: During inflation the fixed income groups are put in trouble. They have to move from one place to another or one market to another for a better bargain price. It costs their time and energy. Menu cost: During inflation the fixed priced shops and companies have to change their price list, price tags and catalogue frequently which costs a lot to them and increases their costs of goods sold. On export: due to inflation a country lose its international competitiveness and its export fall. It also makes the foreign goods cheaper and import increases. Causing adverse effect on their balance sheet(BOP). On exchange rate: when inflation occurs, price of commodities increases and export decreases, for which automatically demand of local currency falls and exchange rate fall. On standard of living: during inflation purchasing power of people fall lead to fall in level of consumption and standard of living.

CONSEQUENCES OF INFLATION Unequal distribution of wealth and income. Poor peoples’ living standard are worse off year after year. Real economic growth slows down. Uncertainty in internal and external investment. Labour unrest in industries especially garments and other labour oriented manufacturing industries. Too much intervention of government in open market ; slowing down the competitive forces. Consumers switches over to imported goods which are cheaper and causes Balance of payment deficit. As a result Inflation becomes accelerating!!!

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