Examine the notion of inflation and how it affects the General Price Level (GPL) of countries prepared by our JC Economics Tutor Simon Ng from Economicsfocus. In other words, governments also strive to keep inflation rate low in order to achieve price stability, which is beneficial to economies. Identify different causes of inflation, such as demand-pull inflation and cost-push inflation, to understand what are the negative consequences of such an economic condition.

economics tuition notes definition


What is inflation?

-A sustained, inordinate and general increase in prices. When this occurs, it implies that the price level has increased over the previous year and this is measured by the consumer price index.

Why is there inflation? What are the causes of inflation?

-Galloping inflation

-Mild inflation


-Demand-pull inflation

-Cost-push inflation

-Structural rigidities

-Imported inflation

-Asset-based inflation


-Tax-based inflation

What is galloping inflation?

-Price increasing beyond 2 digit annually

What is mild inflation?

-Inflation rate is single digit and non-distortionary to relative price. (below 2%)

What is hyper inflation?

-Extremely high inflation rate. (more than 100%)

What is stagflation?

-Stagflation is an economic situation in which inflation and economic stagnation occur simultaneously and is sustained over a period of time. (Loss of output increase and rise in unemployment/rise in price level)

What is deflation?

-A sustained, inordinate fall in general price level of goods and services.

How to calculate inflation rate?

-Using consumer price index (CPI)

What is demand-pull inflation?

-It occurs when there is an increase in the aggregate demand which will contribute to excess demand condition which will lead to the rise in price level under rising cost and full employment condition

What are structural rigidities?

-It refers to the condition of immobility of economic resources due to the inflexibility structural establishments that will lead to rising cost condition as here is a rise in unit cost of resources.

What is cost-push inflation?

-It occurs when there is a rise in cost of production which will lead a fall in the aggregate supply that will lead to an excess demand condition, contributing to increase in price level. When the cycle becomes cyclical, it will develop as wage-price spiral or price-wage spiral.

What are the various types of cost-push inflation?

-Imported inflation

-Tax-based inflation

-Structural rigidities

-Asset-based inflation

What is asset-based inflation?

-It occurs when there is rising prices of assets which will lead to rising cost of condition in term of mortgage loan that will rise of the cost of rental and thus, contributing to cost push inflation

What is imported inflation?

-The rise in global price of certain essential goods or global boom will cause the price of imports to rise which will lead to a rise in cost of living and cost of production, contributing to cost-push inflation. For example, rise in the price of oil.

What is tax-based inflation?

-Increase in indirect tax like GST will encourage producers to raise their price of goods and services. This will trigger the cost of production at respective production and distribution especially in industries where value of tax is not separated from the price of goods (Listed price: $2.00, GST: $0.14)

What is the internal value of money?

-The purchasing power of a unit of local currency on local goods and services which is inversely determined by the price level.

How to determine the internal value of money?

-Decrease in price level will raise the value of money which will lower purchasing power

-Increase in price level will lower the value of money which will raise purchasing power

What is the external value of money?

-The purchasing power of local currency in foreign denomination on foreign goods and services

What is cost of living?

-A theoretical price index that measures the difference in the price level of the amount of good and service one needs to spend in order to maintain the livelihood in an economy.

What is cost of living index?

-It measures the percentage change in unit cost of production of any particular industry.

What is Consumer Price Index (CPI)

-CPI measures relative changes in value of money as a percentage variation in the general price level over a period of time. Price changes are expressed as an index number to show how it differs from a reference/base year.

What is price-wage spiral?

-It happens when big business corporations increase price to increase their profit margin. Cost of living rises and unions may ask for higher wages to make up for loss of living standards. Cost of production and prices eventually will rise.

What is wage-price spiral?

-It happens when powerful union demands for higher wages but is not matched by a corresponding higher increase in productivity. It leads to higher prices and inflationary pressures. Higher prices then lead the unions to again demand higher wages, and the spiral continues.

What are the internal factors of inflation?

-Impact on Investment, Production and Employment

-Unequal distribution of income

-Reduction in level of saving

-Increase in cost of living

-Worsen standard of living

-Undermine main function of money

-Misallocation of money

-Increase in cost of adjustment to adapt to inflation

What are the external factors of inflation?

-Loss of international competitiveness

-Balance of trade and payment deficit

-Depreciation of exchange rate

What are the negative impacts of inflation?

-Loss of international competitiveness

-Balance of trade and payment deficit

-Depreciation of exchange rate

-Impact on Investment, Production and Employment

-Unequal distribution of income

-Reduction in level of saving

-Increase in cost of living

-Worsen standard of living

-Undermine main function of money

-Misallocation of money

-Increase in cost of adjustment to adapt to inflation

How can monetary policy curb inflation?

-With contractionary MP, central bank of the country will reduce money supply by selling treasury bonds and raising interest rates of borrowing. Higher interest rates will push consumers to save and consume less since the opportunity cost of consumption has increased and the cost of credit consumption is higher. As for investment, it will fall as there is increase in cost of borrowing, leading to reduction in profitability. Consequently, AD will decrease and through reverse multiplying process, price will decrease and inflation is curbed, since the excess demand condition is eradicated.

How effective is monetary policy in curbing inflation? What are the limitations of monetary policy in curbing inflation?

-Central Bank cannot control the money supply due to the presence of foreign banks / liberalisation of the banking system

-MEI is interest inelastic – increase in cost of borrowing will decrease investment less than proportionally – interest rate is not reflected on Investment) – Singapore is FDI dominated / if the business confidence is high, the rise in interest rate will not decrease the level of profitability as the level of revenue is still high and thus, the interest is still profitable.

-Although price level stabilizes, there is no growth in the economy. In more extreme cases, the economy will shrink.

-Increases in interest rates will attract hot money inflow from other countries and this will raise the local money supply which will lower the interest rate, making it difficult for the government to conduct contractionary monetary policy.

How can fiscal policy curb inflation?

-Fiscal policy in the contractionary mode decreases government expenditure (G) and raises tax to curb inflation. Reducing G would mean that the government stops spending on public facilities and welfare so that total money supply in the economy is reduced. Increase in taxes will lower the disposable income of the consumers, and reduce profitability after tax and thus decreases government expenditure, consumption and investment

How effective is fiscal policy in curbing inflation? What are the limitations of fiscal policy in curbing inflation?

-Raising tax is a bad political move as it may cause social unrest

-Time lag for policy implementation

-Reduction in essential infrastructure development for the public is not -beneficial (Lower standard of living, lower productivity for the private and public sector)

-Cannot control imported and cost-push inflation

How can exchange rate management policy curb inflation?

-The Central Bank will intervene into foreign exchange rate market to raise the exchange rate by direct intervention where the central bank increases the demand for local dollars through buying of local dollars and selling forex.

-Alternatively, some economies may conduct exchange rate monetary policy by raising interest rate to attract more capital inflow to induce an increase in demand for local dollar which will also appreciate the exchange rate. This will help to curb imported inflation.

How effective is exchange rate management policy curb inflation? What are the limitations of exchange rate management policy curb inflation?

-Strong exchange rate makes import cheaper reduce cost of raw material.

-Exports would be more expensive in terms of foreign currency - fall in X, assuming Marshall-Lerner condition - unemployment in export industries (fall in production)

-Government needs to set aside funds for intervention in FOREX market – raise the opportunity cost of resource - less economic development

-Exchange rate management by raising interest rate is short-lived, since the speculator will sell local $ when it appreciates, therefore increasing the supply of local $ which will lower exchange rate

ow can direct regulation curb inflation?

-Price control – Price ceiling for certain goods below equilibrium

-Income Policy – capping wage at a certain level/Flexible wage structure – fall in variable wage during inflation - dampen cost-push inflation

-Wage and price control seeks to curb wage-price inflationary spiral

How effective is direct regulation in curbing inflation? What are the limitations of direct regulation in curbing inflation?

-Due to extensive government regulation in building facilities, the government is able to control the cost of living to prevent the inflationary spiral

Price policy is against the principle of market forces which wage controls depends on the corporation of the free trade union

Why should inflation rate be kept low? Why is low inflation rate more important than other aims?

-Low inflation helps to prevent unequal distribution of income

(Price of goods for resources is not lowered which will sustain the purchasing power of the lower income group while the price of assets will not rise excessively to raise the wealth of the rich – income and wealth disparity will not widen – social dissatisfaction will be minimised – social stability is promoted)

-It also prevents rise in cost of living and cost of production.

-It also maintains purchasing power and ability to save.

-It will induce investment, production and employment, prevent misallocation of resources

-It helps to maintain international competitiveness due to cost competitiveness

-It helps to prevent the occurrence of balance of trade deficit.

-It helps to prevent fluctuation of exchange rate (depreciation).

What is inflation rate?

-The rate of inflation is calculated as the rate of in­crease of a price index.

What is rising cost condition? What is inflationary condition?

-This refers to a situation where cost of production increases, leading to cost-push inflation.

What is direct regulation?

-It refers to the direct government intervention, where all economic decisions are made by the government itself.

What are the possible solutions to curb inflation?

-Contractionary monetary policy

-Contractionary fiscal policy

-Strong exchange rate management policy

-Supply-side policies like infrastructural development, manpower development, technological development

What is core inflation?

-It refers to the measurement of inflation that excludes specific items that experience volatile price changes, such as private accommodations and transport costs.

What is speculation?

-It refers to the buying or selling of a financial asset, so as to reap quick profit.

What is hot money?

-It refers to money held by foreign investors that is liable to switch to another country’s currency within a short notice, so as to obtain highest returns.

What is capital flow?

-It refers to the movement of capital in or out of a country due to certain factors like market and investor confidence.