INFLATION Defn: A constant process of public price increment in economic.

Example: A pump currently worth RM1, 000 today will worth RM10, 000 in 10 years time. This is due to the decreasing value of money with time. This phenomenon is known as inflation. Causes of Inflation 1) Demand-pull inflation 2) Cost-push inflation a) increase in wages b) increase in profit c) increase in international trade 3) Money inflation Demand-pull inflation Occurs when there is an increase in demand which is over the production of goods. Supply decrease, Demand increase, therefore, Price increase. Cost-push inflation If the economic are expanding, there will be a higher cash flow, this means that income rate will increase. This will also increase the investment. How to increase the investment or production of a firm: i) Increase the number of labour Labour transfer is always happen due to attractive offer from other workplaces. Labour demand is high and this is known as Costpush inflation. The wage rate increases more than the rate of labour force, therefore production cost increases. When the production cost is high, the

manufacturer might gain a little profit or may even loss. Henceforth, to avoid this from happening, the price of products need to increase too. Increase in International Trade Inflation This usually happen because of imbalance of payment for example: Export < Import Money Inflation This is because of the increase in the money circulation. MV = PT , M P

(Money quantity or money circulation (M), therefore public price level (P) ) When the money circulation is increased purchasing power will also increase. Effects from Inflation There will be those who gain benefit from the inflation and some will incur loss. At the early stage of inflation, the increase in production is high (inflation will increase the production). 1) Total Investment & Production When the price level increases, this may create a good opportunity for businessmen, where they will increase their investment with expectation that the total sales will also increase and they will gain profit. Increase in profit will encourage more investment as well as increasing it. 2) Income Distribution a) The Beneficiary Group i) Businessmen They bought the raw material with the old price, old interest rate but they sale their product with higher price. They gain lots of profit.

ii) Debtors The loan value has been decreased because of the price increase during the inflation. Initially the purchasing power of the money is high but because of the inflation, the money value is decreased. Therefore, the debtors will pay lesser than the initial value of their debt. iii) Shareholders They posses shares with non-fix interest rate. During the inflation the profit will increase. When the profit increased, the dividend of the shares will also increase. Hence, the shareholders gain higher profit due to inflation. iv) Farmers Farmers are gaining their wealth in the form of land value, cattle and other physical prices. When the price of goods increased, their production price will increase too. The profit that gains is much higher than the production cost. For example, a farmer might rent some lands or machines or pay the labours with a fixed amount of money, therefore, the production cost is fixed too. But due to the inflation the price of products increase more that usual, thus, he has gained more profit. b) The Group Who Loss i) The Fixed income group During the inflation their purchasing power are low. For example for those with low fix income will experience the impact of the price increase. Their purchasing power is low. Their salary will be reviewed once a while only (after several years)..due to inflation their new salary is actually far behind!! ii) Creditors

the early value that has been credited are considered having loss except for the payment which are made with asset or currency which the value doesnt depreciate. 3) Saving

The saving value in the form of money will decrease. It is better to save in the form of asset such as gold. This is because the value of gold is usually increasing. 4) Losing hope on the currency value Example: Previously with RM 1 we can purchase lots of things, as current it is not worth as before. 5) Workers income degenerate 6) Demand-pull inflation sometimes encourages a negative activity such as stock-hiding. 7) Imbalance of payment Inflation has increased the price of local products compares to the imported products which effect in: a) Demand for local products at foreign market decreases due to price increases, this as well has decreased the export. Export (total export depends on the elasticity demand of export) b) Imported products become cheaper than the local products in the local market. Consumer preferences change. They prefer to buy the imported product which is cheaper. Ways to Control Inflation Inflation control doesnt mean to diminish inflation but it can be controlled by few strategies: 1) Financial Policy 2) Budget Policy

Creditors who are paid with the money which have a lower purchasing power compared to

3) Direct control (if method 1 & 2 are ineffective)

b) Wage Policy Increase in labours wage will also increase the price. Therefore, the increase in wage must not over from the production. The workers union should consider the situation of inflation by not requesting the increment of wage. Wage demand must equal with production capability.

Financial Policy Control that set by the government through the central bank on the local banking system. 1) By increasing the interest rate i) to decrease the purchasing power ii) increase saving (to encourage public to save) 2) By limiting the amount of money circulation and printed. 3) Controlling based on quality Example: Central bank advises the commercial banks to giving loans to only the productive sectors. Rules made for the loaner to pay the first payment at large amount to shorten the period of payment. Budget Policy This policy refers to the government expenses and taxes e.g. income tax. When tax is applied, the expenses will be reduced. This also reduces cash in hand and therefore decreasing the purchasing power. When the government expenses can be reduced the inflation can be lessen. Direct Control a) Done by increasing the production of the necessary products only. Tax will be given to products that are unnecessary for the consumers. If needed, the government can produce the critical and important products on its own.

c) Policy Stringent on Import-Export Activities Only the most required products that can be imported. The local products are given more priority. d) Price Control Price control is done by setting the maximum price of certain products. Practically this is hard to achieve because it is impossible to determine the maximum price. By doing so, will influent the production decisions, create black market and limiting the consumers choices. e) Ration of limited products A fair distribution of products should be done. This is to ensure that the low income consumers will also able to have the products. If it is not well managed it can create black market and corruption. Ration can be done by using coupon system. Everyone will receive coupon which enables to only purchase one limited item of product. Normally, the price of product is fixed. Because the number of coupons distributed is according to the number of products offered, a fair distribution of products among the consumers can be achieved.