Causes of Inflation and Deflation

2181 Words9 Pages
WITH THE AID OF DIAGRAMS, ILLUSTRATE THE CAUSES OF INFLATION AND DEFLATION, AND BY COMPARING THEIR ECONOMIC EFFECTS CONSIDER HOW BOTH CAN AFFECT THE CORPORATE SECTOR.

The essay will describe causes of inflation and deflation and explain how they can affect the corporate sector.

1. INTRODUCTION DEFINITION OF INFLATION AND DEFLATION
Inflation is a process in which the price level is rising and money is losing value. (Parkin, Powell, Matthews p654)

Inflation tends to rise when at the current price level, demand for goods and services in the economy are greater than economy's ability to produce goods and services.
The graph below shows continuously growing inflation, occurred by a rising price level.

If the price level is
…show more content…
As a respond to that workers demand pay increase and with higher cost business need to increase its prices again –that is called cost-push inflation spiral.
Cost-push inflation usually leads to a slower growth of company profits which can then feed through into business investment decisions.

An increase in output prices, such as rise in wage rates or the cost of raw materials, increases firm's costs. With higher costs, firms are less able to make profit. Some firms exit the market and, as a result, aggregate supply is less and shifts to the left. The macroeconomic equilibrium changes, with input prices push up inflation across the economy.
Cost-push inflation usually leads to a slower growth of company profits which can then feed through into business investment decisions.

THE ECONOMICS EFFECTS OF INFLATION AND DEFLATION

Inflation is costly when it is unanticipated because it redistributes income and wealth and creates inefficiency in the economy.
(Parkin,Powell,Matthews p676)

There is widespread agreement that high and volatile inflation can be damaging both to individual businesses and consumers and also to the economy as a whole.
However, economists disagree about the relative seriousness of inflation. The revision notes below cover some of the main economic and social costs associated with persistent inflation in goods and services.
Effect on UK competitiveness - if the
Get Access