Welfare Analysis of Food and

Energy Inflation:
A Representative Agent Approach with
the Lesotho Working Class

P.L. Mohapi & R.I. Thamae

NUL Economics Department
 Introduction
• While inflation is part of life, everyone would
agree that 2008 was a really bad year for the
consumer.

• The Inflation Concept

– Headline Inflation
– Core Inflation
– Components Inflation

• Focus on Components Inflation

– Food and Energy
 Introduction (cont.)
 What does the study actually investigates?
 Two things:
4. The impact of 2008 components inflation on the
representative/average worker’s standard of living.
 This is measured by the worker’s proportion of income
spent on discretionary items.

5. The necessary adjustment in income to immunize

the workers from the effects of components
inflation.
 This is measured by the Compensating Variation.
 Presentation Outline
1. Recent Inflation Developments

2. The Working Class in Lesotho

3. The Representative Worker

4. Analytical Framework

5. Input Data

6. Results

7. Conclusion
 Recent Inflation Developments
 In the OECD countries Food inflation has
tracked Headline inflation between 2.4 – 3.7%
between 2001 and 2005.
 From 2006 Food inflation has jumped above
Headline and rising at a faster rate and
diverging further away from Headline inflation.
 Energy inflation in the OECD countries has
been above Headline inflation by an average of
6 percentage points between 2001 and 2008.
 Recent Inflation Developments (cont.)

In South Africa:
 Food prices “at factory gate” jumped up by
an average 18 % in 2008, compared to 13.8 %
in 2007.

 Petrol and food price increases accounted

for more than a half of the increase in CPIX
inflation, which was measured at 10.4
percent in April 2008
 Recent Inflation Developments (cont.)
The drivers of these developments include:
 Global increased demand for major
commodities –
 E.g.s of continental growth SSA 6%, Asia 9%
 E.g. Over 50% of the increase in demand for oil was
accounted for by India, China & Mid-East
 Biofuels – Demand for grains needed for ethanol
production
 Credit crunch-induced commodity bubble of
2008
 Working Class in Lesotho
Formally employed labor force in Lesotho - 2006
Formal Employment by Sector # Employed Percentage

Basotho mine workers 51,341 30.2

Textile and clothing 40,044 23.6
Government 38,144 22.4
Tourism 22,500 13.2
Construction 6,000 3.5
Wholesale, retail & services 12,000 7.1
Total 170,000 100
 The Representative Worker
 By representative we mean average and the
defining characteristic is income.
 First we recognize that it is difficult to get a truly
representative worker given income disparities.
 Constructed the following representative
workers:
 Low income
 Lower -Middle Income
 Higher-Middle Income
 High Income
 The Representative Worker (cont.)

Table 2: Gross Monthly Income of Respective Representative Workers

Income Classification Gross Monthly GoL Civil Representative

Band Servants in the Gross Monthly
Band Income

Low Income M660 – M2,999 8,644 (54.3%) M1,569.34

Lower-Middle Income M3,000 – M7,999 5,734 (36.1%) M5,033.40
Higher-Middle Income M8,000 – M15,999 1,423 (9%) M10,048.00
High Income M16,000 + 93 (0.6%) M18,846.16

Source: Authors’ computations for GoL civil service payroll data of September 2008
 Analytical Framework

Representative worker’s problem is:

n n
max  x
x1K xn
i 1
i
i where   0 and 
i 1
i 1
n
subject to px i 1
i i m
 Analytical Framework (cont.)
Resulting (Marshallian) demand
functions is:
m
x  i 
*
i
pi
Rearranging it show that <alpha i> is the
proportion of the worker’s income that
goes to commodity i:

pi xi*
i 
m
 Analytical Framework (cont.)
Welfare is measured by the following Indirect
Utility Function:
i
 i 
n
w  V (p, m)  m   
i 1  pi 

Analysis is confined to three commodity

baskets – Food, Energy and Composite
baskets. Therefore:
F E C
 F   E   C 
w  m      
 pF   pE   pC 
 Analytical Framework (cont.)
Impact of inflation on Worker’s
Standard of Living:

  1
n
C 
i F , E

i 1  i
100 
Income adjustment required (measured
by CV):
 p  n
E
 p  n F

CV  m    
E
o   1
F
o
  p  E  p  F 
 Input Data
 To implement the two formulas above the
following variables and parameters are needed
as inputs:
1. Disposable income
2. Workers’ allocation of disposable income to
respective baskets
3. Reported inflation of respective baskets and the
resulting price ratios.

 Table 3 contains data inputs on 1. and 2. while

Table 4 contains data inputs on 3.
 Input Data (cont.)

Table 3: Representative Worker Expenditure Allocations and Disposable

Income
Alpha F Alpha E Alpha C M08:1 M08:2-4

Low Income 0.510 0.156 0.334 1,426.67 1,569.34

Lower-Middle Income 0.443 0.131 0.426 3,558.16 4,051.64
Higher-Middle Income 0.346 0.119 0.535 6,521.33 7,311.13
High Income 0.206 0.120 0.674 11,720.24 13,029.93
Source: Authors’ inferences and computations
 Input Data (cont.)

Table 4: Quarterly Food and Energy Inflation and Corresponding

Price Ratios

Food Energy Food Price Energy

Inflation Inflation Ratio Price Ratio
2008:1 1.723 0.986 1.0172 1.0099
2008:2 3.606 8.664 1.0361 1.0866
2008:3 6.092 7.859 1.0609 1.0786
2008:4 2.221 -1.234 1.0222 0.9877
Source: Authors’ computations
 Results
Table 5: Change in Representative Worker’s Standard of Living
Lower- Higher-
Low Middle Middle High
2008:1 -0.010 -0.009 -0.007 -0.005
2008:2 -0.032 -0.028 -0.023 -0.018
2008:3 -0.046 -0.040 -0.032 -0.024
2008:4 -0.010 -0.009 -0.007 -0.003
Total -0.099 -0.085 -0.070 -0.050

Source: Computations by the authors

 Results (cont.)
 Across income groups, it can be seen that the
second and third quarters of 2008 were the most
difficult, with the third quarter inflation being more
severe.
 The first and fourth quarter inflation had similar
impact across all groups except the high income
group. The fourth quarter inflation impact was milder
for this group.
 Over the entire course of 2008, the low income
suffered most with their std of living declining by
almost 10% while the high income group suffered
least with their std of living declining by only 5%.
 Results (cont.)

Table 6: Compensating Variation against Food and

Energy Price Changes of 2008

Lower- Higher-
Low Middle Middle High
2008:1 14.93 32.16 47.07 56.03
2008:2 53.09 117.07 175.87 245.07
2008:3 76.66 169.68 249.35 321.41
2008:4 16.63 37.53 51.06 44.78
Total 161.31 356.44 523.35 667.29
% Increase 10.28 8.80 7.16 5.12
Source: Computations by the authors
 Results (cont.)
 Once again, across income groups, it can be seen
that the second and third quarters of 2008 were the
most difficult, with the third quarter inflation being
more severe in terms of the required income
adjustment.
 Over the entire course of 2008, the low income
should have secured a 10.28% increase in disposable
income in order to cope with food and energy price
increases.
 The high income group should have ‘scored’ a 5.12%
raise just to cope.
 Makes loads of sense, doesn’t it?
 Summary Results

Lower- Higher-
Low Middle Middle High
% Loss in Std
of Living 9.9 8.5 7.0 5.0
% Increase in
Net Income 10.28 8.80 7.16 5.12
 Conclusion
 Inflation hits low income earners more severely than
high income earners and corresponding income
adjustments should take cognizance of this.
 As long as (net) income growth is slower than inflation,
workers standard of living is bound to decline.
 The reported required increases in disposable income
are for food & energy price increases only.
 Would have probably been higher had inflation on all
other goods in the composite basket been taken into
account.