Demand-Pull, Cost-Push Inflation - Essay Example

Inflation Course 25/01/2016 1735 Words Your name Institutional Affiliation Inflation Inflation is a term used to describe the general rise of consumer goods and services. Inflation is pitied alongside the Consumer Price Index (CPI) which is a general measure of the changes in the general price level of services and consumer goods purchased by households on a yearly basis.1 Accordingly, inflation is measured as an annual percentage increase of prices for goods and services based on and index base of 100 each year. Inflation in this case is perceived to an increase on the CPI value; to imply that the general prices of consumer goods and services have increased. Thus, inflation occurs when the index experiences significant rise in magnitude. Generally, there are two types of inflation that are distinguishable by the speed at which prices of commodities and services rise. For instance, hyperinflation is a phenomenon whereby inflation occurs at a rapid rate and on the other hand, creeping inflation takes shape in a non-destructive manner and is always perceived to always stimulate economic activities. Even though inflation is the rapid increase of the average prices for consumer goods and services, not all prices increase at the same rate. Accordingly, a one-time increase of average prices is totally different from inflation since, it generally occurs within a shorter duration of time before prices stabilize or revert to their original prices. Also, aspects such as creeping inflation can be beneficial to an economy such that the gradual rise of prices is accompanied with increases in wages. In such a scenario, the increase in wages partially results to a kick-back effect whereby, increase in average prices has little effects to the demand of goods and services. In fact, it is at this period that businesses tend to leverage on higher profits based on an increase in wages and other productive activities. Demand-pull inflation Demand-pull inflation takes place whenever there is an increase in the aggregate demand, on the sections of the macro economy C + I + G (X – M) exceeds the cumulative supply when all of the resources have been utilized. In such a scenario, the utilization of all the resources results to firms being limited from increasing their supply. This implies that there shall be a short supply of goods and services resulting to a demand of the commodities that are in scarcity on the market. The inadequate supply of products and services in a situation whereby there is increased demand elicits in the prices considering that the commodities are short supply. Accordingly, the short supply of consumer goods and services amidst an increase in demand, results to an upward trend in price increase amidst the “bid prices up” based on buyer preferences, resulting to inflation.1 In the demand-pull inflation, the economy is normally characterized by the presence more money in circulation that is required to purchase fewer goods available in the market. As earlier mentioned, the inflationary period is an occurrence that results from the gradual increase of commodity prices and services. In connection to the demand-pull inflation, products and services are in scarcity as a result of all available resources being utilized in full capacity resulting to the availability of fewer products amidst increasing demand. To the Keynesian economists, inflation is characterized by the presence of idle resources going into full use resulting to the production of fewer products on the market. Whenever the aggregate supply curve remains flat, demand-pull inflation is bound to be restricted from occurring as a result of activities taking place below the full-employment level as seen on the Aggregate Supply (AS) and Demand Curve (AD) graph below.1 Once the full-employment output level has been reached, the AS becomes vertical to signify the limitation of an output level from being increased.2 Accordingly, an increase in the AD results to a rise of the price levels between P1 and P2 causing demand-pull inflation to occur.3 Cost-push inflation Cost-push inflation occurs as a result of a rise in the cost of production leading to increased prices of consumer goods and services.4 Accordingly, cost-push inflation takes place whenever “there is a decrease in the aggregate supply of goods and services as a result of an increase in the cost of production”.1 in other words, cost-push inflation arise from the increase in prices that assist in the production process such as capital, labour, entrepreneurship, and land especially when industries are running at full production capacity. With an increase in production costs, companies normally maximize their productivity and leverage on marginal profit margins by repetitively producing the same amount of goods and services. In order to stem the rising costs of production, the increased costs are passed on to consumers resulting to an increase in the average price level of goods and services, causing inflation to occur.2 The rising costs of production can be attributed to factors such as a rise in the cost of production due to increased wages without any corresponding rise in productivity.3 Normally, this aspect occurs when trade and workers unions demand for higher wages regardless of whether there is an increase in production or not.4 Unlike the influence on the rise of wages, cost-push inflation can also be influenced by the control of monopoly on the available resources potent for production. For instance, whenever prices of production components are artificially increased by a monopoly controlling stake, production of goods and services becomes affected. This implies that, industries can become exposed to costly raw materials as a result of price controls by mostly cartels, resulting in an increase in the cost of production, which is in turn transferred to the consumer. A good example of cost-push inflation occurs in the global oil industry through which crude oil prices come under the control of the Organization of Petroleum Exporting Countries (OPEC). OPEC normally plays a major role in the control of crude oil prices globally, with oil companies transferring the increased cost of oil to the end consumers.1 This occurs when there are increased production costs in the extraction of crude oil within OPEC members. By looking at Keynesian economists, a shift experienced in the AS towards the left results to an increase in the average price levels of consumer goods and services, causing cost-push inflation. By looking at the graph below, it can be ascertained that an AS curve that is flat on the lower part of the graph below P1 might climb swiftly especially when the full-employment output is approached. Cost-push inflation A subsequent rise in the cost of production results to the AS curve shifting from AS1 to AS2 causing an upward trend on the shift of prices from P1 to P2 casing cost-push inflation to occur.1 National income National income is normally based on two aspects of the economy, Gross Domestic Product (GDP) and the Gross National Product (GNP) that are normally used as an economic indicator of the performance of an economy.2 In this case, GDP is referential for the sum of value of all the goods services that have been produced in an economy for a period of one year. On the other hand, GNP is the sum of the value of all the goods and services generated by an economy regardless of their location.1 Accordingly, GDP play a major role in determining the market value of products within an economy in terms of monetary value. Contrary, there are other items within an economy that do not have a market value and cannot be included as part of the GDP. GDP can be calculated using various approaches such as the output approach, income approach, and the expenditure approach.2 In this case, the income approach can be used to determine the profit taxes deductible form the profits generated from the sale of goods and services within an economy. Given that inflation influences the purchasing power of the economy, higher inflation rates can decrease the amount of collectable profit and income tax rates. Generally, a higher economic growth benefits the society from collectable taxes being utilized to overcome instances of poverty and assist in driving government functions. Mostly, profit tax is deductible from the gross profits generated by companies meant for the purposes of driving government functions to the people. However, a reduction in the profit taxes can amount increased capital gains to the company shareholders. Given that profits are part of the amount shared among the shareholders, reduction in profit taxes can amount to increased monetary power to industry owners that can be invested back towards production of goods and services. In comparison, income taxes is the tax deductible from the wages of an employee.3 Accordingly, a reduction on the income taxes would amount to employees having increased spending power that can be used to acquire goods and services contentedly. Notably, any increase in spending power can result to instances of cost-push inflation whereby people have more money to spend. Contrary, the economy can leverage on an increase in production as a result of a reduction in profit taxes to stabilize the prices of products and services. Given that GDP is calculated from the national income obtainable from the final production of goods and services, the economy is bound to be strengthened considering the fact that money cannot vanish from the economy.1 Thus, the economy is expected to benefit from increased economic activities based on the increase in the amount of money that is in circulation as a result of low taxes. According to the Economic Review Committee (ERC) on taxation in Singapore, a reduction of taxes spurs economic growth and increases employment rates.2 Additionally, lower income taxes have resulted to an increase in household income that is beneficial to the people when it comes to spending power. On the other hand, tax incentives offered to the manufacturing and services sector ensures that the cost of production is maintained at competitive levels, placing companies at the helm of competing on a global level.3 In other words, a reduction in profit tax and income tax reduces cost of production limiting hyperinflation through maintaining the stability of the prices of goods and services within feasible levels.4 Given that GDP is calculated based on the monetary value of the amount of goods and services produced, a reduction of income and profit taxes would ultimately spur economic growth within a country, resulting to the rise in GDP. References Cheuk-yin, L, Economic Goals. In, SOSC A101 Unit 9, Hong Kong, ETPU Publishing Team, 2011. Cheuk-yin, L, Market and National Income. In, 159 SOSC A101 Unit 8, Hong Kong, The Open University of Hong Kong, 2015. ERC, Restructuring the Tax System for Growth and Job Creation. In, Singapore, Economic Review Committee, 2016. Hall, R, Inflation: Causes and Effects. In, 3rd ed., Chicago, University of Chicago Press, 2009. Read More