CHAPTER SIX
INFLATION
Introduction
Inflation is defined as a persistent and generalized increase in the level of prices. It is a process in
which the price level is rising at a rapid rate and the money is losing its value.
Inflation refers to an economic situation where the demand for goods and services in the
economy is continuously increasing without corresponding increase in supply which pushes the
general prices up. The opposite of inflation is called deflation. Inflation is measured by
considering the Consumer Price Index (C.P.I) which involves comparison of prices of certain
goods and services for two different periods.
In constructing the C.P.I;
1. A basket of commodities is selected which includes selecting the generally consumed
commodities by average consumers.
2. Choosing the base period which should be a period when the prices were fairly stable.
3. The price of commodities both in the current period (P1) and base period (P2)
Types and causes of inflation
Inflation is classified in relation to its causes.
Demand pull inflation
This is a type of inflation caused by excessive demand for goods and services without a
corresponding increase in production resulting into rise in prices.
Causes of demand pull inflation
a. Increase in population; increased number of people in a family calls for increased demand
of goods and services thus fueling demand-pull inflation.
b. Increase in government expenditure; The government expenditure has the effect of making
money available to people thus increasing the aggregate demand for goods and services.
c. A fall in the level of savings; this increases the consumer expenditure on goods and services
which brings pressure on the available goods and services thereby pulling up prices.
d. Effects of credit creation by the commercial banks; when banks lend more money to the
public, their purchasing power increases hence increasing demand which in turn leads to
increase in the prices.
e. Consumers’ expectation of future price increases; when consumers expect the prices of
goods and services to increase in the future, they will buy more in the present thus increasing
the demand thus fueling demand-pull inflation.
f. General shortages of goods and services; Any shortage in goods caused by factors such as;
adverse climatic conditions, hoarding, smuggling, withdrawal of firms from the industry and
decline in level of technology calls for scramble for the available goods thus increasing their
demand and prices.
Cost push inflation
This is a type of inflation caused by increase in cost of factors of production which translates to
increased prices of goods and services.
Causes of cost push inflation.
COMMERCE II COURSE NOTES: CHAPTER 6 – INFLATION PREPARED BY MR. ANTONY AMBIA Page 1
, Increase in wages and salaries; an increase in the wages and salaries may increase the cost
of labor. The increased cost of labor may be reflected in the increased prices of commodities
which in turn would cause wage push inflation.
Increase in cost of raw materials and other inputs; this increases the cost of production
thus increased prices.
Increase in indirect taxes; this increases the cost of production and this causes firms to raise
the prices of their product.
Increase in profit margin; If the business decides to raise its profit, it leads to an increase in
the price of the commodities resulting to profit push inflation.
Reduction in subsidies; removal of a subsidy implies that the producer would produce at a
higher cost that was being met by the subsidy. This increase cost is finally reflected in
increased prices.
Imported inflation
This is a type of inflation which is caused by importation of high priced inputs of production
such as; technology/machines, skilled human resources and crude oil.
This in turn increases the prices of locally produced goods which may lead to inflation.
Causes of imported inflation
1. Importation of expensive technology especially highly skilled labor.
2. Importation of expensive machines and equipment.
3. Importation of high priced oil.
4. The currency depreciating thus increasing the price of the country's imports.
LEVELS OF INFLATION
a. Mild / Creeping/Moderate Inflation; this slow rise in price level of not more than 5 % per
annum. It is associated with some beneficial effects on an economy especially to firms and
debtors.
b. Galloping /Rapid Inflation; this is a very rapid accelerating inflation characterized by a
situation whereby the general prices levels increase rapidly.
c. Stagflation; this is an economic condition in which unemployment is high, the economy is
stagnant, but prices are rising.
d. Hyper /Runway Inflation; this is when prices are rising at double or triple digit rates of
20%, 100%, 200%. The price levels are extremely high and under this situation people may
lose confidence in the money as a medium of exchange and as a store of value.
Effects of inflation in an economy
Desirable effects of inflation
a. Mild inflation motivates people to work hard as they try to cope with the effects of the
inflation in order to maintain their standards of living.
b. Mild inflation encourages proper utilization of resources with an attempt of avoiding wastage
as much as possible.
c. Mild inflation increases investment especially in trading activities since sellers buy goods
when prices are low and sell later when prices are higher.
d. It promotes creativity in an economy in terms of production in order to survive the effects of
inflation.
COMMERCE II COURSE NOTES: CHAPTER 6 – INFLATION PREPARED BY MR. ANTONY AMBIA Page 2
INFLATION
Introduction
Inflation is defined as a persistent and generalized increase in the level of prices. It is a process in
which the price level is rising at a rapid rate and the money is losing its value.
Inflation refers to an economic situation where the demand for goods and services in the
economy is continuously increasing without corresponding increase in supply which pushes the
general prices up. The opposite of inflation is called deflation. Inflation is measured by
considering the Consumer Price Index (C.P.I) which involves comparison of prices of certain
goods and services for two different periods.
In constructing the C.P.I;
1. A basket of commodities is selected which includes selecting the generally consumed
commodities by average consumers.
2. Choosing the base period which should be a period when the prices were fairly stable.
3. The price of commodities both in the current period (P1) and base period (P2)
Types and causes of inflation
Inflation is classified in relation to its causes.
Demand pull inflation
This is a type of inflation caused by excessive demand for goods and services without a
corresponding increase in production resulting into rise in prices.
Causes of demand pull inflation
a. Increase in population; increased number of people in a family calls for increased demand
of goods and services thus fueling demand-pull inflation.
b. Increase in government expenditure; The government expenditure has the effect of making
money available to people thus increasing the aggregate demand for goods and services.
c. A fall in the level of savings; this increases the consumer expenditure on goods and services
which brings pressure on the available goods and services thereby pulling up prices.
d. Effects of credit creation by the commercial banks; when banks lend more money to the
public, their purchasing power increases hence increasing demand which in turn leads to
increase in the prices.
e. Consumers’ expectation of future price increases; when consumers expect the prices of
goods and services to increase in the future, they will buy more in the present thus increasing
the demand thus fueling demand-pull inflation.
f. General shortages of goods and services; Any shortage in goods caused by factors such as;
adverse climatic conditions, hoarding, smuggling, withdrawal of firms from the industry and
decline in level of technology calls for scramble for the available goods thus increasing their
demand and prices.
Cost push inflation
This is a type of inflation caused by increase in cost of factors of production which translates to
increased prices of goods and services.
Causes of cost push inflation.
COMMERCE II COURSE NOTES: CHAPTER 6 – INFLATION PREPARED BY MR. ANTONY AMBIA Page 1
, Increase in wages and salaries; an increase in the wages and salaries may increase the cost
of labor. The increased cost of labor may be reflected in the increased prices of commodities
which in turn would cause wage push inflation.
Increase in cost of raw materials and other inputs; this increases the cost of production
thus increased prices.
Increase in indirect taxes; this increases the cost of production and this causes firms to raise
the prices of their product.
Increase in profit margin; If the business decides to raise its profit, it leads to an increase in
the price of the commodities resulting to profit push inflation.
Reduction in subsidies; removal of a subsidy implies that the producer would produce at a
higher cost that was being met by the subsidy. This increase cost is finally reflected in
increased prices.
Imported inflation
This is a type of inflation which is caused by importation of high priced inputs of production
such as; technology/machines, skilled human resources and crude oil.
This in turn increases the prices of locally produced goods which may lead to inflation.
Causes of imported inflation
1. Importation of expensive technology especially highly skilled labor.
2. Importation of expensive machines and equipment.
3. Importation of high priced oil.
4. The currency depreciating thus increasing the price of the country's imports.
LEVELS OF INFLATION
a. Mild / Creeping/Moderate Inflation; this slow rise in price level of not more than 5 % per
annum. It is associated with some beneficial effects on an economy especially to firms and
debtors.
b. Galloping /Rapid Inflation; this is a very rapid accelerating inflation characterized by a
situation whereby the general prices levels increase rapidly.
c. Stagflation; this is an economic condition in which unemployment is high, the economy is
stagnant, but prices are rising.
d. Hyper /Runway Inflation; this is when prices are rising at double or triple digit rates of
20%, 100%, 200%. The price levels are extremely high and under this situation people may
lose confidence in the money as a medium of exchange and as a store of value.
Effects of inflation in an economy
Desirable effects of inflation
a. Mild inflation motivates people to work hard as they try to cope with the effects of the
inflation in order to maintain their standards of living.
b. Mild inflation encourages proper utilization of resources with an attempt of avoiding wastage
as much as possible.
c. Mild inflation increases investment especially in trading activities since sellers buy goods
when prices are low and sell later when prices are higher.
d. It promotes creativity in an economy in terms of production in order to survive the effects of
inflation.
COMMERCE II COURSE NOTES: CHAPTER 6 – INFLATION PREPARED BY MR. ANTONY AMBIA Page 2
