Iprices

all
of ofgoodsand. services increases in price level are moderate and
not excessive. For policy makers to correct
Jevel producedin an economy. Sinceit
are
thatcomposite of prices of all goods and excessive inflation, they must first know
isa
a itis more fully:referred to as the
services, what is causing it,which willallow them
level. Policy makers are to put the correct set of policies in place to
aggregate price
ensurethatthe aggregate price- reduce this inflation to an acceptable level.
keento
of an
economy does not rise rapidly This acceptable level is considered tobe
levell
year, i.e. they are concerned generally about 2 to 3 per cent. What are
fromyearto of inflation?
aboutinflation. the causes and consequences
Causes of Inflation
Table
5.3
RATE (CONSUMER PRICES) different
BARBADOs INFLATION
In answering thisquestion,
CHANGES INC
CONSUMER PRICES BETWEEN 2003-2008 economists, while acknowledging that
there are other forces at work, place
Percent Date of
Inflationrate Rank
Information
emphasis on different aspects of the
Year (consumerprices) Change
2002 est. consider
economy. Some economists
-.60% 212
2003 -16.67 % 2003 est. demand
inflation to be a problem on the consider
.50% 214
2003 est.
2004 0.00 % others
side of the economy, while
.50% 3
2005
-.50 % 6 0.00% 2003 est.
it to be mostly aproblem with the supply
2006
-.50% 5 0.00 % 2003 est.
direct their attention to the
side; still,others
2007 -1,200.00% 2007 est.
Let us now
008
5.50% 132
monetary policies of a country. of these
arguments
examine some of the
economists.

Inflation
What is Inflation? Demand pull inflation
View:This view
Inflation refers to a persistent and * The Keynesian of
holdsthat a primary cause
Sustained rise in the aggregate price inflation occurs when aggregate
a year,
level over some period; usuallypoint in demand in an economy
exceeds
The
0r, Over a period of years.
price-level changes supply ofgoods
the aggregateThis
time from which such the base year. and services.
means that the
are measured is known as productive capacity of a country
rise in price
When we speak of a general about an increase
goods
cannot generate sufficientdemand of
level, we are not talking and services to meet
the
but an increase in view assumes that
n the price of one good, an economy, lr the country. This
in
the prices of most goodsrapidly producing at
from period an economy is already
level or on its
Price levels were to rise give rise to a its full employment frontier, and
lo period then this would Consequencesin an production possibility more
pressure for
number of undesired Please so any additional
and on society in general. goods and services will
trigger
economy
note that price levels usually rise over time,
inflation or what is known as
an
nation's gets
as a Consequence of growthin a demand inflationary gap. This situation
Population, and hence, growthin makers worse when firms try to
respond
within its economy. What policy thatsuch tothe excess demand by producing
are Concerned about is ensuring
 Economic Managementa Poltcles and doals

more of
more and demandingresources. In
already fully utilized in a
this situation, any increases
country'snational income is only
innational
a monetary increase increase in the
income but not a real
country's physical output,and will
only result in price increases in the
economy.
* The Monetarist View: The
monetarist view of inflation is also
fundamentally demand pull. Here,
the belief is that where there are
excessive increases in money supply Figure 5.7 Costpush inflation.
over the rate of growth in the
productionof goods and services
will
in any economy then inflation
result. Higher levels of money in
Imported inflation
an economy should keep pace with
the rate of growth of real output. There are many times when inflation ie
According to this view, the failure the result of international events. The
of policy makers to ensure that most common situation is when the nri%
this occurs will lead to a situation
for the important and major imports ofa
where 'too much money will chase country, such as oil and foodstuff, increas
too little goods, therefore leading to internationally. In this case, countries that
inflation.
are very dependent on these imports, for
raw material or other uses, will be affected
Cost-push or profit-push inflation by these price increases and will be forced
to increase the cost of any related goods
Cost-push or profit-push inflation is and services in their country. Here we say
based on the independent decision made
by those who are entrepreneurs and that the country is importing inflation.
administrators to increase the price of
factors of production. For example, any Consequences of Inflation
increase in the wage rate in an industry or Price-level inflation
country will force employers to raise the
price of goods and services to clear the new Among the principal consequences of
wage rates. In sonme cases, companies with excessive price-level inflation is:
monopoly or oligopoly power can increase * A decline in thevalue of money
prices without any regard for the economic will
condition of a country. An increase in that is, a dollar spent today
Secure much less if left to be spen
electricity, for example, might trigger a tomorrow.
general increase in prices in an economy.

240
 [Link] real income. Do you Distortion of business decisions
recall what real income is? Refer to
Section3to refresh your memory. When price levels increase rapidly, this has
The distortion of business the effect of distorting business decisions.
*
decisions; that is, business decisions ror example, if someone takes a loan from
being made on one set of prices the bank for the purpose of investing the
which change rather suddenly after money in a business venture, he or she
would most likely have done so on the
#hese decisions have been made.
assumption that prices would remain
relatively stable. What do you think would
value
pecline in money happen if prices were to rise rapidly? Well,
Inflation causes a decline in the value if subsequently prices were to rise rapidly,
of money since it erodes the purchasing then certain unwanted developments may
OCcur such as:
powerofthat money. For example, if
intheyear2003, the cost of the average * The investor's business prospects
would be different from what he
hasket of groceries for an average-sized
household was $1 000.00, but in 2004. he or she anticipated since his or her
same basket of groceries cost $1 150.00, then projected revenue streams would be
this represents a 15% price increase. That hampered by the rising prices.
is. 150/1000 x 100 (150 divided by 1 000 * The investor's capacity to repay
multiplied by 100). What does this mean for the loan is also in trouble because
the consumer? For the consumer, this price he or she is now left with less than
increase means that, apart from the fact expected revenues.
that the same basket of groceries cost more * The value of the bank's loan would
in 2004, the $1 000.00which would have have declined (this would be the
Durchased this same amount of groceries case for any other loans which the
in 2003, now in 2004 would purchase bank had extended) and the value
significantly less. In short, the purchasing of all repayments on interest and
power of the consumer's income has been principal would have also declined.
eroded. This also represents a rise in the This would hurt the bank in its
cost of living. primary business of extending
loans and credit and could result
in the bank's failure to continue
Decline in real income in business. This in turn would
Inflation also causes adecline in the create other serious macroeconomic
real income of society's members. As problems throughout the economy.
you learnt earlier, real income is income
measured in terms of what can be bought Allof these factors ilustrate the potential
with it. Clearly, if the prices of goods and of inflationary surges to upset business
services rise faster than income, then plans and decisions, which will have severe
the money value or purchasing power Consequences on economies.
Would have fallen. Such a situation would
Notice that it was mentioned above that
Tesult in falling living standards because
nouseholders or consumers would now be inflation has the potential to cause serious
able to purchase far less goods and services macroeconomic consequences. By this we
for their income. mean that from a wider macroeconomic

241
 1omic Management: Policies an

they are concerned with the

Perspective, inflation has the potential
that anation's gross domestic real go
to destabilize an economy. Given
prices are rising, this means that
costs of
production within the economy are ris1ng
that is, they are Concerned
the economy's real GDP. prowidtuhct grow(G
The result of this is that there would be a Let us consider. an
reduction in the total value of goods and whose income has exampl
increased eof a
family 0
services supplied. This being so,
of the economy's total output or its
value
the
national
to $1 000 000..We
assume that the
may be
te f
mptro
emd to
income is negatively affected. How do you has improved family' s fi nanci al
think this will affect the country's national were to even dosituaise
But what if yousignincantly, learn
income? in that same period,,the
priceslaintert that
country also doubled? Rhet
On the demand side of the economy,
the inflationary pressures would cause
anation's exports to become price
may start figuring Immediaftaemily,y's
out that the
situation has really not changed. No
what if you were further
uncompetitive. This is because the prices
would be too high for other nations to find size of the family also doubled? informedOf courthatse,te
it cost effective to trade with this country. this further information may
As a result, there would be a reduction the situation of the
family may
revealthat
in export demand as well as the value of have worsened. The same is very well
total demand for that economy. In general,
true in trying
to ascertain whether there is
real
in an economy. There are other growth
excessive inflation causes an economny
to contract. An economy contracts when must be taken into considerationfabefora
ctors tha
economic activities are significantly it is assumed that the economy has tru
reduced and its grovwth is slowed down grown. We will now examine the fol owing
considerably. definitions used by macroeconomic
planners to indicate or describe the trye
You may wonder just how economists
are aware when an economy is being
performance of an economy during a
one-year period.
destabilized or is contracting. The answer is
that they have found away to measure the
value of the goods and services produced Nominal GDP
in an economy. We discussed some of these
measurements earlier when we looked Nominal GDP is the value at market
at the calculations of national income. prices of total final output of goods and
Briefly, we will now mention sonme of the services within a nation during agiven
other measurements that are important to year. This total amount is a money igure t
stabilizing the economy and are related to has not been adjusted for inflation or pris
price stability. or even how income is distributed in the
population.
Nominal, Real and Potential
Output Keal GDP
Here, a specific reference is being made to
Real GDP is nominal GDP which has
the prices and the opportunities for growth
in an economy. As policy makers seek to been adjusted to cater for the efects of
tackle the issues of growth in an economy, price-level inflation. It is calculated at
picture
constant prices and gives the trruest

242