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The site provides interactive access to a range of activities related to the New Zealand economics curriculum at Years 12 and 13. There are interactive notes, exercises, practice examination papers, a glossary, and useful economics websites.
Inflation is an increase in the general level of prices over a stated period of time, usually a year, expressed as a percentage. When prices on average go up, that's inflation. The fundamental cause of ongoing inflation is too much money chasing too few goods. Inflation usually happens when the economy is too buoyant, so that shortages of labour and materials become widespread, and prices in general rise. Then money starts losing its value. Typically an inflation-linked boom is followed by a bust.
If prices rise faster than incomes, then people are worse off. As well, if interest paid on savings is less than inflation, then the interest is inadequate to compensate people for the fact that the value of their savings is being eaten away.
Inflation also does long-term damage to the economy. When money doesn't hold its value, businesses and investors have more difficulty making contracts, especially where contracts have to last over time, eg employment contracts and borrowing. This discourages long-term, quality investment in the nation's productive capacity.
Inflation was high during the 1970s and the 1980s, peaking at 18.4 per cent per annum in 1980. Since 1991, inflation has been low and stable.
Types of Inflation
1. Demand-Pull
This is inflation caused by the total demand exceeding the current supply. This is a particular problem when the economy is at full employment.
Why? - Aggregate Monetary Demand(AMD) rises
C = Consumers' expenditure(taxes down, money supply up)
I = Investment rises
G = Gov't expenditure rises
X = Demand for exports rises
Effects
1. Prices rise - inflation P2 - P3
2. Output and employment rise E2 - E3
3. Excess capacity is partially removed, but at the cost of higher prices.
2. Cost-Push
This is rising prices caused by rising production costs, union wage negotiations, or bosses, seeking more profits.
Why? - Costs, esp. MC, rise.
1. Higher Labour or raw material costs.
2. Higher indirect taxes(GST)
3. Greater inefficiency and lower productivity
Effects
1. Prices rise - inflation P2 P3
2. Output and employment fall E2 E3
3. Excess capacity is increased
From the 2 types of inflation above it is important to realise that the choice of the right policy solution; eg. - if we reduce demand in a cost push inflation the level of prices might fall but the excess capacity would increase and unemployment rise.
There are other differences between cost-push and demand-pull inflations.
Demand-Pull - tend to have higher profits and more investment
Cost-Push - lower profits and more redundancies, greater concentration of production into fewer firms and lower investment.
Demand-Pull - tend to have higher profits and more investment
Cost-Push - lower profits and more redundancies, greater concentration of production into fewer firms and lower investment.
Inflation Animation
In this example I have used Aggregate Supply and Aggregate Demand curves to show Demand Pull and Cost-Push inflation. This relates to National Output.
Inflationary Expectations
In recent years more attention has been paid to the psychological effects which rising prices have on people's behaviour. The various groups which make up the economy, acting in their own self-interest, will actually cause inflation to rise faster than otherwise would be the case if they believe rising prices are set to continue.
Workers, who have tended to get wage rises to 'catch up' with previous price increases, will attempt to gain a little extra compensate them for the expected further inflation, especially if they cannot negotiate wage increases for another year.
Consumers, in belief that prices will keep rising, buy now to beat the price rises, but this extra buying adds to demand pressures on prices.
In a country such as New Zealand's before the 1990's, with the absence of competition in many sectors of the economy, this behaviour reinforces inflationary pressures. 'Breaking the inflationary cycle' is an important part of permanently reducing inflation. If people believe prices will remain stable, they won't, for example, buy land and property as a speculation to protect themselves.
