1. Inflation is an increase in the average price level of the goods and services in the economy. The unexpected inflation will shrink income. The greater the rate of inflation the lower will be the quantity of goods and services that can be bought from the given nominal income. Nominal income does not measure the actual purchasing power, this is measured by real income. Real income is the actual number of dollars received adjusting to the change in the price level. If the CPI (Consumer Price Index) increases and the nominal income remains the same, the real income i.e. the purchasing power decreases. Thus the consumers can buy little from the same amount of income they had before inflation occurred. Inflation also affects the wealth and the interest rate. Inflation can benefit the wealth holders since the value of assets often increase faster than the rise in consumer price. On the other hand, those who do not have wealth may suffer since due to rise in assets faster than inflation, it becomes difficult to acquire wealth. Unexpected inflation may benefit the borrowers. The real interest rate is equals to nominal interest rate minus the inflation rate. If the inflation rate is 10% and the nominal interest rate is 5% then the real interest rate will be -5%. This means even though the nominal interest rate of 5% is paid, the actual purchasing power will fall by 5% since the inflation rate is 10%.
Authorities can assure the markets, consumers and producers that they will keep inflation low by firstly, making sure individuals and businesses does not spend money quickly to buy goods and services when inflation occurs in fear of paying more tomorrow. Secondly, making sure nominal interest rate does not increase with the increase in inflation otherwise this will make the payments of installments difficult. Thirdly, making sure wage-price spiral does not continue to a greater extent. And making sure the new factories, machinery and technological research are carried out. Also the government should not print money to pay bills which will rise prices frequently, sometimes increasing in minutes.
2007-10-27
15:39:56
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7 answers
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Anonymous
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Economics