Topic: Inflation

What is inflation?

Inflation is the general increase in prices and fall in the purchasing power or value of money.

Normally, inflation is caused by several things happening within the economy.

Types of inflation.

Moderate or creeping inflation – it is normally defined as a single digit inflation. Galloping inflation – it is a very high rate of inflation in double or triple digits. Hyper inflation – Here, increase in prices becomes a signal for an increase in wages and costs in an economy. This sends prices up and the process continues. Such a rapid rise in price is called hyper inflation. At hyper inflation money loses its value so fast that no one wants to use it as a medium of exchange.

Causes of inflation.

Money supply

National debt

Exchange rate

Demand – pull effect

Cost – push effect

Money supply

When more money is supplied within the economy, its face value will decline. This is because more money will be chasing few goods /commodities and thus will result in increase in demand of commodities with in the market. People will want to buy more and more definitely because they have more money in their hands.

National debt

National debt is the total amount of money which a country’s government has borrowed.

The government can choose to pay the debt in two way. They can either try to raise more money by increasing taxes or by printing more money. If they increase more taxes, companies will have to shift the tax burden to the public due to increase in corporate tax rate. This will result to increase in commodity prices. However, if they decide to print more money, it will result devaluation of money as explained in point number 1.( money supply).

Exchange rate

Inflation can be made worse by our increasing exposure to foreign marketplaces. In Kenya, we function on a basis of the value of the Kenyan shillings. On a day-to-day basis, we as consumers may not care what the exchange rates between our foreign trade partners are, but in an increasingly global economy, exchange rates are one of the most important factors in determining our rate of inflation.

When the exchange rate suffers such that the Kenyan currency has become less valuable relative to foreign currency, this makes foreign commodities and goods more expensive to Kenyan consumers while simultaneously making Kenyan goods, services, and exports cheaper to consumers overseas.

This exchange rate differential between our economy and that of our trade partners can stimulate the sales and profitability of Kenyan corporations by increasing their profitability and competitiveness in overseas markets. But it also has the simultaneous effect of making imported goods (which make up the majority of consumer products in Kenya), more expensive to consumers in Kenya.

Demand – pull effect

The demand – pull effect states that as wages increase within an economic system (often the case in a growing economy with low unemployment), people will have more money to spend on consumer goods. This increase in liquidity and demand for consumer goods results in an increase in demand for products. As a result of the increased demand, companies will raise prices to the level the consumer will bear in order to balance supply and demand.

An example would be a huge increase in consumer demand for a product or service that the public determines to be cheap. For instance, when hourly wages increase, many people may determine to undertake home improvement projects . This increased demand for home improvement goods and services will result in price increases by house – painters, electricians, and other general contractors in order to offset the increased demand. This will in turn drive up prices across the board.

Cost – push effect

Another factor in driving up prices of consumer goods and services is explained by an economic theory known as the cost – push effect. Essentially, this theory states that when companies are faced with increased input costs like raw goods and materials or wages, they will preserve their profitability by passing this increased cost of production onto the consumer in the form of higher prices.

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