Inflation Investigation Economists say that inflation refers to as a continual rise in the general level of prices. An increase in the general level of prices for goods and services will cause a decrease in the purchasing power of the currency. While inflation is defined as an increase in the level of prices, not all of these prices necessarily change by the same proportion or even in the same direction. FIND AN EXAMPLE Because of this, inflation affects the distribution of real income and wealth among individuals and households.
Inflation can cause many significant economic effects. For example, it can have an impact on the distribution of national income and wealth. The relative rates of inflation in Australia and inflation rates overseas can influence international competitiveness. A low and stable rate of inflation is desired for the welfare of the economy and for individual benefit. Measuring Inflation The most common way to measure inflation is to calculate the rate of change of the Consumer Price Index (CPI). The CPI summarises the overall change in the prices of a large number of goods and services.
The CPI is based on a sample of a range of goods and services arranged in the following eleven groups: This sample of goods is referred to as the regimen (the different groups of goods and services included in the sample). In Australia, the CPI is calculated by the Australian Bureau of Statistics (ABS) and is compiled on a quarterly basis by collecting approximately 100,000 price quotations. The ABS attaches a weight to each item in the CPI regimen in order to reflect its importance to the ‘average’ household.
For example the average household would consider a 10% rise in the price of fuel more important than a 10% rise in the price of cellophane. Reviews of the importance of the eleven groups are reviewed every five years in order to keep an accurate reflection on the household’s buying patterns and what is considered important. For example, ‘average’ households in the last decade have been found to buy more leisure and recreation goods than before; thus, the price movements have become more important.
It must be taken into consideration that the CPI does not account price movements that are outside of metropolitan areas and also does not represent the true cost of living as it does not show the changes of consumer or substitutions of preferences on a day to day account compared to relative price changes. The rate of inflation refers to the rate at which prices are changing and is conducted from the CPI. The rate of inflation is calculated from the CPI using the following formula: Quarterly rates of inflation can still be found using the same formula but instead using quarterly results instead of yearly.
Causes of Inflation Demand-Pull Inflation There are various causes for inflation, depending on a number of factors. Inflation can often occur when too much money is printed in order to deal with a crisis. As a result, prices end up increasing at an extremely high rate to keep up with the currency surplus. This is known as demand-pull inflation, where we have ‘too much money chasing too few goods. ’ And the economy is said to be ‘overheated’. Therefore, prices are forced upwards because of a high demand and/or the purchasing power of the money decreases.
Demand-pull inflation arises when aggregate demand in an economy exceeds aggregate supply. It involves inflation rising as real gross domestic product rises and unemployment falls. This would not be expected to persist over time due to increases in supply, unless the economy is already at a full employment level. Fortunately for consumers, the effects of demand-pull inflation are generally short-term. Demand pull-inflation occurs when demand for a product increases and firms cannot keep up with the new level of demand so, rather than increase the supply of the product they raise the prices in order to eliminate the excess demand.
This is shown in the diagram above, demand increases from AD to AD’ therefore equilibrium price increases from Pe1 to Pe2 and quantity increase from Qe1 to Qe2. However, if for any reason firms cannot increase output then they will raise the prices and then demand will decrease. Cost-Push Inflation Another common cause of inflation is known as cost-push inflation. This occurs when there is a rise in production costs, which leads to an increase in the price of the final product or retail price. If prices were to remain the same, the firm’s profit margin would decrease, so prices rise in order to keep the same profit margin.
For example, if raw materials increase in price this causes the cost of production to increase, which results in higher prices. When the costs of production increase, producers rather pass this burden onto the consumer, rather than reducing profit margins. Rising labour costs can also lead to inflation. If workers demand wage increases, companies usually choose to pass on these costs to the buyers by increasing the price of the good or service. International Trading Inflation can also be caused by international lending and national debts.
As nations borrow money, they have to deal with interest, which causes prices to rise as a way of keeping up with their debts. A severe drop of the exchange rate can also result in inflation because governments will have to deal with differences in the import and export level. Taxes Federal taxes put on consumer products can also cause inflation. As the taxes rise, suppliers often pass on the burden to the consumer however; once prices have increased they may not go back even if the taxes are later reduced. Another cause for inflation is war, as governments must get back the money spent and repay the money borrowed from the bank.
War often affects everything from international trading to labour costs to product demand, so in the end it always produces a rise in prices. |Year |Mar |Jun |Sep |Dec |Annual | |2008 |4. 2416% |4. 5079% |4. 9811% |3. 6852% |4. 3526% | |2007 |2. 4358% |2. 0739% |1. 8626% |2. 9582% |2. 3324% | |2006 |2. 9831% |3. 9757% |3. 9386% |3. 2537% |3. 5385% | |2005 |2. 595% |2. 4862% |3. 0261% |2. 7986% |2. 6687% | |2004 |1. 9816% |2. 4770% |2. 3223% |2. 5910% |2. 3436% | The graph above shows the quarterly inflation percentages in Australia from 2004-2008. From March 2004 until June 2006 there has been a gradual upward trend with the exception of a few minor downturns. The upward trend was probably due to the economy expanding thus leading to the boom that occurred. During this time period, the peak occurred during June 2006 at 4%.
Then from September 2006 to September 2007 inflation rates declined from 3. 9% to 1. 9%. From then until September 2008 the rate of inflation was once again increasing from 1. 9% to 5% which happens to be the peak of the entire graph. The high increase in the rate of inflation occurred because Australia was at its boom stages within the economy so prices were driven up. Since then, inflation rates have dropped to 3. 7% as the global financial crisis struck every economy in the world. MORE NEEDED Australia in the Global Economy Australia was the world’s 14th largest economy by nominal GDP, with a size of $889 billion in 2007.
After a recession in the 1980s [pic]Australia had 16 years of uninterrupted growth, which was supported by growing demand for [pic]commodities and robust government policies. GDP long-term growth has averaged 3. 3% between 2003 and 2007, but is expected to drop to the 2-3% range in the next five years. [pic]Australia is a western market economy. The largest sector is the services sector, which contributed for 72% of the GDP in 2007. [pic]Australia is a major exporter of natural gas, coal, iron, bauxite, copper, tin, gold, silver, uranium, tungsten, mineral sands, lead, zinc, opals, diamonds, grain, wool, meat and food products.
Even though the mining and agricultural sectors are small, they make up approximately 65% of Australia’s exports despite only making up 4. 7% of GDP combined. In 2007 [pic]Australia imported $228 billion of goods and services and it exported $216 billion. (CIA World Factbook) Australia’s main export partners are Japan, China, South Korea, USA and India. The main import partners are the USA, China, Japan, Singapore, and Germany. Australia has a favorable trade balance, but has a current account deficit of 5. 8% that is expected to continue until 2012 according to the International Monetary Fund.
This shows large interest payments against foreign debt. While traditionally tied to Europe and US, [pic]Australia is now dependent on Asia for its economic well-being. It partners with Japan for capital financing, especially in the mining industry, and with China as its primary export partner. The Australian economy has also been supported by a housing market boom and a strong national currency. Attached is a table comparing inflation rates and unemployment rates in Australia and other developed countries from 2003-2008. Economic Growth
With the recent financial crisis that is happening all over the world and affecting major economies like the United States of America, Australia has been doing very well to remain stable as it is the only developed economy that has missed a recession (which might be due to the stimulus package that was given out). Since we have missed a recession, it means that we have not had two consecutive negative quarters of economic growth, so our spending in the economy has not declined so much. If we were to have hit a recession, then spending within the economy would have decreased therefore inflation would have also decreased.
Since our economic growth has obviously grown spending within the economy has increased and if we were to get recent inflation statistics it would show that inflation would have increased within the two quarters. Also, with an increase in economic growth/activity, income levels rise, resulting in a cycle of having a higher purchasing power (which immediately makes demand pull inflation) but, greater purchasing power means that aggregate demand will increase so producers may have to supply more meaning costs of production will increase, meaning cost push also increases.
Unemployment Rates In 2004, Australia’s unemployment rate was 5. 4% having a percentage change of -9. 26% from the previous years. Australia’s natural rate of unemployment is said to be an estimate of 4%. Nevertheless, this does not mean Australia was going bad within the economy. Having a rise in unemployment means that consumers do not have much income thus spending within the economy reduces. This can be seen in the inflation rate during the 2004 as the highest inflation had gotten during that year was 2. 6% in December.
Since inflation reached its peak in 2008, it appears to be that unemployment was at 4. 2%, the lowest it had been for many years. This shows that unemployment has a direct connection with the inflation rates as it shows the spending within the economy (thus the demand and supply for goods and services). |YEAR |UNEMPLOYMENT RATE (%) | |2004 |5. 4 | |2005 |5. 1 | |2006 |4. | |2007 |4. 4 | |2008 |4. 2 | From the graph above we can see the inflation rates and unemployment rates in Australia for each quarter from 2004-2008. It can be said that the unemployment rates (shown in blue) has a general downward trend whilst the inflation rates (shown in red) seem to have an upward trend except for late 2006/early 2007 WHY??
From this information we can draw the conclusion that there is a definite connection between unemployment and inflation. As unemployment decreases, inflation decreases and vice versa. (This is known as inverse proportion. ) This is very clearly illustrated in July 2006 when there was a significant drop in unemployment and at the same time a relatively large increase in inflation rate was recorded. Towards the end of 2007 and during 2008 unemployment rates were on the rise and inflation rates reacted by dropping dramatically after July 2008.
MORE Reference Page Books: Parry, G. and Kemp, S. (2009), Discovering Economics, pp. 195-205. South Perth, Tactic Publications Pty Ltd. Internet: http://www. imf. org/external/pubs/ft/scr/2008/cr08312. pdf http://www. abs. gov. au/ausstats/abs@. nsf/0/43742A462F6606ECCA256E7D0000264A? opendocument https://www. cia. gov/library/publications/the-world-factbook/geos/as. html http://www. indexmundi. com/australia/inflation_rate_(consumer_prices). html http://en. wikipedia. org/wiki/Inflation http://tutor2u. et/economics/revision-notes/a2-macro-causes-of-inflation. html http://www. economywatch. com/inflation/causes. html http://en. wikipedia. org/wiki/demand_pull_inflation ———————– CPI (year2) – CPI (year1) (100 CPI (year1) CPI (year1) 1. Food 2. Alcohol and tobacco 3. Clothing and footwear 4. Housing 5. Household contents and services 6. Health 7. Transportation 8. Communication 9. Recreation 10. Education 11. Financial and insurance services. Pe2 Pe1 Qe1 Qe2
