Effects of Inflation

Inflation is defined as a keep up accession in the general train of legal injurys which ensues in a mitigate in the purchasing power of bullion. Inflation is measured through the Consumer outlay Index (CPI) which measures proportional changes in prices in a re modelative field goal of gns, weighted according to their importance in a typical Australian households budget. The RBA cultivates to keep flash at an annual direct of 2-3%, and in order to do this a number of policies ar uncommitted for the Australian government.Keeping Inflation under control is a primary commercial enterp swot for the Australian Government as it affects so some different part of the Economy, including Economic produce, standard of musical accompaniment and unemployment. There are three types of ostentatiousness, depending on their braces. Firstly, conduct pull s wholesomeing occurs when there is an excessive hoard hire at or near full employment. If aggregate demand exceeds aggregate come forth, prices of gns rise as a circumscribe mechanism. This form of inflation is commonly associated with periods of elevated economic activity.Secondly is cost-push inflation. If business cost such(prenominal) as the cost of wages or materials rise, businesses may aim to maintain profit levels by passing these cost onto consumers. This depart result in higher prices and therefore inflation. The final type of inflation is merchandise inflation. Imported inflation occurs when the price of imports rises, and either adds to business costs (resulting in cost-push inflation) or feeds into the CPI as the price of final goods. Furthermore, a depreciation in the Au$ entrust shift import prices, in addition adding to merchandise inflation.There are a number of factors which may effort inflation in the Australian economy. A major cause of demand-pull inflation is excessive growth in aggregate demand. If aggregate demand increases from AD to AD1, aggregate allow which is th e equivalent of real gross domestic product will rise to GDP2 and the price level will rise from P to P2. This results in the inflationary gap of cd. This increase in aggregate demand may be the result of a number of factors, including increases in consumption expenditure, investment spending, net government expenditure, the money supply, or export incomes.Another major cause of inflation, this time cost-push inflation, is a diminution in aggregate supply. If aggregate supply decreases from AS to AS1, real GDP will decrease to GDP2 and the price level will rise to P1. This results in both a contraction in real GDP and a rise in inflation. The main causes of this decrease in aggregate supply is excessive wage growth not accompanied by productiveness increase, a rise in the cost of naked as a jaybird materials, and other inputs, or a rise in government taxes or other charges that raise costs for firms.Cost-push inflation may also be the result of merchandise inflation it there is a rise in humankind prices of import goods used in the production process (such as raw materials and median(a) goods) firms are likely to pass these costs onto consumers, resulting in inflation on the other hand if there is a rise in world prices of consumer goods, increased import prices will feed directly into the CPI, also resulting in inflation. Furthermore a depreciation in the Au$ in international exchange markets will result in a rise in the prices of imported raw materials, intermediate goods, and consumer goods, again contributing to Australias inflation.This is demonstrate in the stimulus when the RBA credits the decrease in inflation to the attenuation impact of 2000s exchange rate depreciation. A slight common cause of inflation is the existence of monopolies or oligopolies. If a monopoly or oligopoly exists in an industry, the leave out of competition allows producers to push up prices. This again results in inflation. The final cause of inflation in Australia is i nflationary expectations. Inflationary expectations refer to the behaviour of individuals and businesses who stress to compensate for the current inflation, as well as expected in store(predicate) price rises.This may be the result of either firms pushing up prices, or wage earners seeking higher nominal wages. Also, if consumers expect in store(predicate) prices to rise, they rather buy gns now, which leads to increases in spending. This results in demand-pull inflation. Inflation can impact the economy in 3 ways. 1)By encourage investment in speculative and unproductive activities and discouraging investment in ventures considered productive. Inflation encourages investment in real assets such as golden and real estate because they are considered good shelters for inflation.This is because the scarcity of them often outpaces or at least keeps pace with the rate of inflation. If inflation occurs, people will seek to own such assets, shifting resources to these speculative and unproductive assets. alike this discourages investment in other assets. This is because entrepreneurs will not think it is financially viable to invest and pursue a project that will just now result in less(prenominal) profit, due to the higher costs of inflation. likewise inflation increases the cost of production thus also discouraging entrepreneurs.For example, if inflation is high, people will invest in gold and real estate. otherwise known as the opportunity cost, because people will allocate their resources into such ventures (gold and real estate) they must and then forego investing into other ventures that are considered productive such as a new business, that may be producing corking goods or normal goods and services. Also by discouraging entrepreneurs is the rise in the costs of production that occur due to inflation, for example the raw materials.Similarly interest rates will rise, making it more expensive to lift out funds for investment purposes, making investmen t projects less profitable. Either way, inflation can cause a wrong in production of capital goods, leading to lower living standards in the future, or a loss in the production of normal goods and services, leading to lowering current living conditions, as current needs and wants go unsatisfied. Since returns from productive capital come upon longer to materialise, it means that entrepreneurs are also faced with a lesser return.This means that if the rate of inflation is greater than the return offered by the investment, then the project will not be considered economically viable, nor worthwhile. Similarly the essay of loss from any investment project will grow with inflation. more small businesses take a couple of years before they stick out to make a profit, so if inflation is high, and is was not taken into forecast when the business was first planned, then the cost of production may rise, and the resulting price for the commodity will be too high for consumers. ) If inflat ion is present and is greater than that overseas, it reduces the overseas competitiveness of the Australian economy. This is because inflation is not entirely associated with a rise in prices, but also an increase to the costs of production. Therefore making overseas exports cheaper to the domestic market. Similarly the overseas firms do not have to put up with the rises in the costs of production. This provides a leakage in the circular flow (purchase of exports) and thus conquer demand in the domestic market, which if severe enough could lead to a recession, speech with it many economic problems.An example of how inflation can lead to a recession, would be the 1970s, when high inflation averaged at 10. 4%. Which due to the high oil prices and strong domestic demand conduct to high inflation in the 1980s (8. 1%). This period of high inflation led to a dampening in spending and a recession in the 1990s (1990-1992) causing many problems such as unemployment. 3) It also creates man y winners and losers in the economy. Those that expediency are the owners of real assets (real assets and gold), because their assets are worth more.As well as those belonging to well-organized groups who can demand wage increases (eg, strong guile unions. ) This can lead to rapidly rising wages, increasing the costs of production, and also discouraging investment in productive capital as mentioned above. In addition to this inflation can benefit people who have already borrowed funds because the cost of repayment, represent less as inflation rises. This is because inflation is defined by a loss in the real appreciate of money, therefore the repayment will diminish over time.Conversely inflation disadvantages those on fixed incomes because they lose the real economic value of income as their money represents less purchasing power. Similarly for the same reasons it disadvantages those that keep their money in placid form (ie, bank deposits). Also those that lend money receive les s back in terms of repayment, due to the loss in value (eg, A mortgage repayment in 1960 was worth more than in 1980, where high inflation had occurred).Also since it reduces international competitiveness, inflation can disadvantage exporters who abide by themselves with less business opportunities. This can effect the economy, as overseas markets will not purchase Australian goods and services. Therefore the economy will not receive the injection into the circular flow that it would usually, without inflation. Without the strong domestic deport that is present in Australias economy, the economy could have the effect of dampening economic activity, and aggregate demand.When inflation occurs in the Australian economy it usually had a number of causes. The main causes are excess aggregate demand, cost-push inflation, inflationary expectations and imported inflation. inflation disadvantages many groups in the economy, who in turn benefit other groups. This is because inflation can in fluence the allocation of resources in regards to further and discouraging investment, the overseas competitiveness of the Australian market, as well as effecting individuals and firms, who often benefit at the expense of others.