Effects of Inflation Essay

Keeping Inflation under control is a elemental concern for the Australian Government as it affects so m some(prenominal) varied parts of the Economy, including Economic fruit, standard of living and unemployment. There be terce guinea pigs of inflation, depending on their examples. Firstly, subscribe on pull inflation occurs when on that point is an excessive conflate assume at or near full employment. If mass demand exceeds compound supply, expenses of gns pilfer as a rationing mechanism. This form of inflation is usually associated with periods of blue frugal activity. secondly is cost-push inflation. If railway line be such as the cost of wages or materials rise, businesses whitethorn aim to primary(prenominal)tain profit levels by reaping these costs onto consumers. This forget firmness in higher prices and thence inflation. The final exam type of inflation is aftermathed inflation. Imported inflation occurs when the price of imports rises, and either adds to business costs (resulting in cost-push inflation) or feeds into the CPI as the price of final goods. Furthermore, a disparagement in the Au$ go away raise import prices, also adding to imported inflation.There are a number of factors which whitethorn origin inflation in the Australian providence. A major(ip) cause of demand-pull inflation is excessive growth in aggregate demand. If aggregate demand increases from AD to AD1, aggregate supply which is the equivalent of real GDP impart rise to GDP2 and the price level go away rise from P to P2. This results in the inflationary gap of cd. This increase in aggregate demand may be the result of a number of factors, including increases in consumption expenditure, enthronisation spending, net government expenditure, the money supply, or export incomes.An other(a) major cause of inflation, this time cost-push inflation, is a decrease in aggregate supply. If aggregate supply decreases from AS to AS1, real GDP leave behind decre ase to GDP2 and the price level will rise to P1. This results in both a concretion in real GDP and a rise in inflation. The main causes of this decrease in aggregate supply is excessive wage growth not accompanied by productivity increase, a rise in the cost of raw materials, and other inputs, or a rise in government taxes or other charges that raise costs for firms.Cost-push inflation may also be the result of imported inflation it there is a rise in world prices of imported goods used in the re sprain process (such as raw materials and arbit outrank goods) firms are likely to pass these costs onto consumers, resulting in inflation on the other hand if there is a rise in world prices of consumer goods, increased import prices will feed directly into the CPI, also resulting in inflation. Furthermore a depreciation in the Au$ in foreign exchange markets will result in a rise in the prices of imported raw materials, intermediate goods, and consumer goods, again contributing to Aust ralias inflation.This is demonst sum upd in the stimulus when the RBA assign the decrease in inflation to the fading invasion of 2000s exchange rate depreciation. A slight common cause of inflation is the existence of monopolies or oligopolies. If a monopoly or oligopoly exists in an industry, the lack of competition allows producers to push up prices. This again results in inflation. The final cause of inflation in Australia is inflationary expectations. Inflationary expectations refer to the behaviour of individuals and businesses who seek to compensate for the authorized inflation, as easy as expected future price rises.This may be the result of either firms pushing up prices, or wage earners seek higher nominal wages. Also, if consumers expect future prices to rise, they rather buy gns now, which leads to increases in spending. This results in demand-pull inflation. Inflation eject impact the economy in 3 ways. 1)By encouraging layment in unsound and unproductive activi ties and discourage investment silver in ventures considered productive. Inflation encourages investment in real assets such as gold and real estate because they are considered good shelters for inflation.This is because the scarcity of them often out treads or at least keeps pace with the rate of inflation. If inflation occurs, people will seek to own such assets, shifting resources to these speculative and unproductive assets. Similarly this discourages investment in other assets. This is because entrepreneurs will not think it is financially viable to invest and quest for a project that will only result in less(prenominal)(prenominal) profit, due to the higher costs of inflation. Similarly inflation increases the cost of output thus also discouraging entrepreneurs.For example, if inflation is high, people will invest in gold and real estate. Otherwise known as the prospect cost, because people will allocate their resources into such ventures (gold and real estate) they must hence forego investing into other ventures that are considered productive such as a new business, that may be producing capital goods or convention goods and services. Also by discouraging entrepreneurs is the rise in the costs of work that occur due to inflation, for example the raw materials.Similarly interest rank will rise, devising it more expensive to borrow funds for investment purposes, making investment projects less profitable. Either way, inflation can cause a loss in issue of capital goods, leading to frown living standards in the future, or a loss in the production of normal goods and services, leading to lowering current living conditions, as current needs and wants go unsatisfied. Since returns from productive capital take longer to materialise, it agency that entrepreneurs are also faced with a lesser return.This means that if the rate of inflation is greater than the return offered by the investment, then the project will not be considered economically viabl e, nor worthwhile. Similarly the risk of loss from any investment project will grow with inflation. Many small businesses take a couple of years before they start to make a profit, so if inflation is high, and is was not taken into account when the business was graduation planned, then the cost of production may rise, and the resulting price for the commodity will be too high for consumers. ) If inflation is present and is greater than that oversea, it reduces the overseas competitiveness of the Australian economy. This is because inflation is not only associated with a rise in prices, but also an increase to the costs of production. Therefore making overseas exports cheaper to the house servant help market. Similarly the overseas firms do not wipe out to put up with the rises in the costs of production. This provides a leakage in the circular flow (purchase of exports) and thus dampening demand in the domestic market, which if severe enough could lead to a recession, bringing w ith it many economic problems.An example of how inflation can lead to a recession, would be the 1970s, when high inflation averaged at 10. 4%. Which due to the high oil prices and steady domestic demand led to high inflation in the eighties (8. 1%). This period of high inflation led to a dampening in spending and a recession in the 1990s (1990-1992) do many problems such as unemployment. 3) It also creates many winners and losers in the economy. Those that welfare are the owners of real assets (real assets and gold), because their assets are worth more.As well as those belonging to well-organized groups who can demand wage increases (eg, strong trade unions. ) This can lead to rapidly rising wages, increasing the costs of production, and also discouraging investment in productive capital as mentioned above. In accompaniment to this inflation can benefit people who have already borrowed funds because the cost of repayment, represent less as inflation rises. This is because inflati on is delimitate by a loss in the real apprize of money, therefore the repayment will diminish over time.Conversely inflation detriments those on fixed incomes because they lose the real value of income as their money represents less purchasing power. Similarly for the same reasons it disadvantages those that keep their money in suave form (ie, bank deposits). Also those that lend money receive less back in terms of repayment, due to the loss in value (eg, A mortgage repayment in 1960 was worth more than in 1980, where high inflation had occurred).Also since it reduces international competitiveness, inflation can disadvantage exporters who find themselves with less business opportunities. This can motion the economy, as overseas markets will not purchase Australian goods and services. Therefore the economy will not receive the injection into the circular flow that it would usually, without inflation. Without the strong domestic support that is present in Australias economy, the economy could have the effect of dampening economic activity, and aggregate demand.When inflation occurs in the Australian economy it usually had a number of causes. The main causes are excess aggregate demand, cost-push inflation, inflationary expectations and imported inflation. inflation disadvantages many groups in the economy, who in turn benefit other groups. This is because inflation can influence the allocation of resources in regards to encouraging and discouraging investment, the overseas competitiveness of the Australian market, as well as effecting individuals and firms, who often benefit at the expense of others.