Illustrate The Causes if Inflation And Deflation Essay

With the serve of diagrams, illustrate the causes if splashiness and deflation, and by comparing their frugal effects postulate how both(prenominal) tin can effect the corporal sectorThis essay forget aim to cover the causes of puffiness and deflation and see how their frugal effects charm the embodied sector. By first defining any key terms, wherefore looking at the causes of ostentation and deflation, looking at their different effects on the thrift and in turn analysing how those effects shape the bodily sector. Before this can be done the terms lump, deflation and in collectived sector must first be defined. Inflation is a wage hike in the average charge of goods over eon. (Begg, D., Fischer, S. and Dorndusch, R., 2000, p462) and The most frequent measure is that of retail prices (Sloman, J. and Sutcliffe, M., 2001, P533) (this information be ga thered from the retail price index RPI) and A rise in ostentatiousness mode a faster increase in pricesf all in all in pretentiousness authority a slumper rise in prices (Sloman, J. and Sutcliffe, M., 2001, p533).To illustrate the importance of inflation The COS (Central Statistical Office) says it gets more(prenominal) queries from the public about the RPI than any former(a) statistic, a refection of the influence inflation has on alwaysy ones life. (Vaitilingam, R., 1994, p132). Now deflation must be defined. Deflation is the mirror image on inflation (McAleese, D., 2004, p285) and is defined by the Collins English dictionary as reduction in economic activity resulting in lower output and enthronization (Anon, 1998, p140). Corporate means relating to a descent corporation (Oxford University Press, 2006) so the corporate sector is all profit making businesses.This report get out now examine the principal(prenominal) causes of inflation. in that respect atomic number 18 two chief(prenominal) types of inflation beg draw out and mo sack upary value push. Demand pull inflation occu rs when a rise in aggregate convey leads to an increase in overall prices (Begg, D. and Ward, D., 2004, p237). Sloman, J. and Sutcliffe, M., (2001, p537) represented this diagrammatically stating The AD curve shirts to the right and continue to do so. Firms pull up stakes react to a rise in aggregate look at partially by raising prices and partly by increasing output (a move up the AS curve) and this is illustrated in the following diagramThis new, higher level of requisite my happen for umteen reasons Atkinson, B. and Miller, R., (1998, p378) tell us that The high level of demand may originate from consumers, from firms, from overseas or from the government.The other main cause of inflation is apostrophize push inflation. Cost push inflation occurs when a reduction in give leads to an increase in overall prices (Begg, D. and Ward, D., 2004, p237) or when cost of production rise independently from the level of demand (Atkinson, B. and Miller, R., 1998, p378). This can be d e noned diagrammatically asSloman, J. and Sutcliffe, M., (2001, p357) describe this graph as Cost-push inflation is associated with continuing rises in cost and hence continually leftward (upward) shifts in the AS curve. If the firm case a rise in cost, they forget respond partly in raising prices and passing the be onto the consumer and partly by cutting back on production (there is a deed a big the AD curve)Monetarists believe that inflation is caused solely by the tack of bullion in circulation. The monetarist view of inflation, encapsulated in Milton Friedmans dictum, inflation is ever so and everywhere a monetary phenomenonInflation occurs when the growth of the money supply persistently exceeds the growth of unfeigned output (McAleese, D., 2004, p281). This can overly be order of battlen graphically asMcAleese, D., (2004, p281) goes on to say thatA rise in money supply from M0 to M1 shifts the AD curve outwards from AD (M0) to AD (M1). The even uptual equilibrium w ill move from E0 to E1 and prices will rise from P0 to P1In the short runthe AS curve may be positively slopedIn that event a rise in money stock will cause higher prices, but will similarly lead to more outputIn the presbyopicer term, pay levels will catch up on inflation and, over time The parsimoniousness so approximates more and more closely to the vertical AS.This theory is approve by much evidence including this from the US Department of CommerceAs deflation is the opposite inflation it can be caused by the same factors. McAleese, D. (2004, p285) state it can be caused by supply or demand shocks. put out shocks includesustained productivity improvements and technological innovation that lowers prices of inputs and outputsDemand shocks can arise for several reasons a collapse in the stock merchandise or property prices, a sustained strengthening of the exchange rate, warsthat undermined business confidence. From a monetary perspective deflation is caused by a reduction in the velocity of money and/or the amount of money supply per person. (Wikipedia contributors, 2006). Kai, V., L. (2004) showed this graphically asKnow we how inflation and deflation is caused we must examine their effects on the economy as a whole and their effects on the corporate sector. Sloman, J. and Sutcliffe, M., (2001, p534) believe that If you could accurately predict inflation and adjust incomes and prices to meet it then it would non be problem. And Griffiths, A. and Wall, S., (2004, p463) reinforce this by stating if we spend a penny an economy in which inflation is proceeding at a steady and suddenly foreseen rate, and in which all possible adjustments for the existence of inflation have been imprintthe main cost of inflation would arise from the fact that interest is not ordinarily nonrecreational on currency in circulation, so individuals would make more trips to the bank in order to collect interest on their money.These extra trips to the bank argon often call ed shoe-leather cost of inflation. (Griffiths, A. and Wall, S., 2004, p463) The other cost of anticipated inflation is menu costs. Menu costs are costs from having to update catalogues, menus, vending machines, etc (Atkinson, B. and Miller, R., 1998, p384). These costs are very minute so would not greatly effect the corporate sector as a whole. Businesses such as restuants, catalouge based comapies and those who produce vending machines would incounter minor expenses. This forseen inflation econany can be represented graphically asBut normally high inflation is not accurately predicted so other economic costs arise. There are four main, other, expenses redistribution, hesitancy, balance of payments and resources. This report will now look at these factors in turn.Firstly high inflation redistributes wealth to those with assets (e.g. property) and away from those with savings that pay rates of interest below the rate of inflation and hence whos value is eroded by inflation (Sloman , J. and Sutcliffe, M., 2001, p534). This may include people on fixed pensions. Atkinson, B. and Miller, R., (1998 p384) show redistribution also effects creditors , those who are owed money, will also behave, since when they are paid back, the value of money will be worth little, while debtors, those who owe money, will profit. So Firms can also borrow more for enthronisation as real value of debt decreases (Atkinson, B. and Miller, R., 1998, p386). This will be a benefit to firms to wishing to borrow money but bad for those who killer long term credit options on their products.Secondly inflation tends to cause uncertainty and firms may be reluctant to plan ahead and take long term decisions regarding investment funds as they are unable to predict prospective costs and revenues. (Atkinson, B. and Miller, R., 1998, p384) This will abase the rate of economic growth. (Sloman, J. and Sutcliffe, M., 2001, p534). So the corporate sector will suffer from poor planning and low inves tment. furthermore inflation is likely to worsen the balance of paymentsits exports will gravel relatively less(prenominal) competitive in the world markets. At the same time imports will become relatively cheaper than home produces goods. Thus exports will cash in ones chips and imports will rise. As a result the balance of payments will drip and/or the exchange rate will fall. (Sloman, J. and Sutcliffe, M., 2001, p534). This will, then, affect companies who rely on the global economy. They will face difficulties to exporting products and selling them abroad. They will also face increased competition from imports so may even fight back to sell their products to the home market.Finally extra resources are likely to be used to cope with the effects of inflation. Accountants and other financial experts may have to be employed by companies to help cope with the uncertainties caused by inflation. This will then increase a firms costs. With higher costs, firms are less able to make profit. Some firms exit the market and, as a result, aggregate supply is lesswith national output travel and inflation increasing. (Begg, D. and Ward, D., 2004, p238) firms are forced to pass on increasing costs onto the consumer which may result in reduced sales. This could result in being fatal to a firm in a high inflationary economy.So the economy as a whole will suffer from high inflation, firms will find new obstacles in the way of maximising profits and the individual in the economy will each face new difficulties as a result. Sloman, J. and Sutcliffe, M., (2001, p536) report The costs of inflation are likely to be relatively mild if kept to the single intent problems arise if inflation turns into hyperinflation (where inflation accelerates out of control) and go onto say If inflation develops into hyperinflation Firms constantly raise prices in attempt to cover their rocketing costs. Workers demand gigantic pay increase in an attempt to stay ahead of the rocketing cost of living. Thus prices and wages chase each other in an ever rising inflationary spiral.Even though the effects of hyperinflation, and even inflation, can be devastating to an economy and the corporate sector, most economic expert fear deflation more. This section will now examine the effects of deflation on the economy and businesses. McAleese, D., (2004, p286) reported In assessing the economic effects of deflation the problem stems less from the shock itself than from the sequence of events that follow and magnify its initial impact. Price declines become self reinforcing. This means if deflation is affecting an economy, consumers will expect prices to fall as they have been. This will mean they will postpone buying a certain product now as they believe that in the rising it will be cheaper or as they become more pertain about their future economic security, particularly if unemployment is rising.The prolonged economic retardant in Japan has raised concerns about future income prospects among its aging weary force, which may well be one reason for its deflation of the last fewer years (Brooks, D. H. and Quisingp P., F., 2002). This all means demand will fall. Weakening consumer demand passes into investment. Investors begin to loose nerve. Sales forecasts are cut back. The appetite for jeopardize weakens. Faced with declining sales, corporate debt that once looked rock solid now looks less secure firms cut back on the number of employees (McAleese, D., 2004, p286). So not only does the corporate sector suffer from declining sales, they are forced to reduce their prices even more. They have reduced investment opportunities as capital becomes extremely hard to raise.Deflation has opposing influences on creditors and debtors Consequently, the real value of debt and debt servicing rises. There is thus a potential benefit for creditorsBy itself this redistribution of real net wealth is not necessarily negative for the economy as a whole. (Brooks, D. H. an d Quisingp P., F., 2002). For firms with a high level of debt this means decreased security as the cost of their debt is increasing. This will also have negative implications on investment as another route of raising capital becomes increasingly more difficult to peruse. Firms that offer credit options will benefit as the real value of they owed increases. The effects of deflation are seen more server in at onces economy as McAleese, D., (2004, p286) believes In an open world economy, there is an added fear that deflationary impulses in a large economy could be transmitted across countries through trade and investment linkages.Inflation and deflation both affect the corporate sector in various ways. Constantly low inflation should bring increased stability. Businesses seeking to invest millions of pounds over galore(postnominal) years will be assured by increases price stability. Predictions regarding costs and revenues are much easier to make and firms face less uncertainty when a ssessing investment risk. (Begg, D. and Ward, D., 2004, p286) and low inflation is likely to increase the turnover and profit levels of a firm. Workers may also feel happier with pay increase therefore more productive under the illusion they are better off even though their real wage has not increased. So in conclusion low inflation can be beneficial to the corporate sector but higher inflation can have many negative affects but It is generally better to have mild inflation than deflation. Deflationcan create a potentially dangerous situation, as occurred during the slack of the 1930s. (Atkinson, B. and Miller, R., 1998, p386).BiblographyAnon, 1998, Collins Gem English dictionary (Nineteenth Edition), HarperCollins Publishing, GlasgowAtkinson, B. and Miller, R., 1998, Business economic science, Pearson Education Limited, EssexBegg, D., Fischer, S. and Dorndusch, R., 2000, political economy (Sixth Edition), McGraw-Hill Publishing Company, Berkshire.Begg, D. and Ward, D., 2004, ec onomic science for business, McGraw-Hill Education, BerkshireBrooks, D. 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