INFLATION.

Inflation refers to the persistent increase in the general price level of goods and
services in an economy in a given period of time.

It occurs when the demand for goods and services persistently increases beyond
the output level so that there is a tendency for the prices of goods and services and
for the factors of production to rise because they fail to keep the place with demand
for them.
When we say an economy is experiencing inflation, we mean that prices of most
commodities are rising leading to increase in the average price level and decline in
value of money.

MEASUREMENT OF INFLATION
P 1−P0
Inflation can be measured using the consumer price index i.e. P0
X 100
Where P1 is the current price index and P0 is base year/reference year price index.

Note: when P1 exceeds P0 it implies that inflation has occurred.

For example
if the price of sugar in 2002 was 2000 /- and 2006 it was 3000/- calculate the rate
of inflation in that period of time.

P 1−P0 3000−2000 1000

= P0
X 100 = 2000
X 100 = 2000
X 100 = 50%.
It means that if the base year prices were at 100%, this means that the general price
level of basic consumer goods has risen to about 150% of the base year prices.
The value of money will have declined, real income will have fallen and goods
have become expensive hence standard of living has declined.

TERMS USED IN INFLATION

1. Stagflation: This refers to a situation where there are high levels of inflation
and high levels of unemployment or stagnation in an economy. It occurs during
a depressionary period.
1|ECON NOTES BY A.N
 Costs of stagflation/ Demerits.
 Increases the cost of living.
 Promotes brain drain.
 Reduces government revenue from taxation.
 Leads to decline in peoples welfare.
 Leads to reduction of level of savings and investments.
 Increases income inequality/ worsens a problem of income inequalities.
 Leads to erosion of confidence in country’s currency.
 Leads to social distress/tension among people.

How to reduce stagflation/ measures to reduce stagflation

 Reduction in taxes so as to increase disposable income.
 Liberalizing monetary policy e.g by reducing interest rate on capital.
 Increasing Gross Net Product/output by using investment incentives.
 Increasing government expenditure to encourage production.

2. Reflation:
This refers to deliberate government policy to force price upwards to recover
from depression
Or deliberate government macroeconomic policy designed to increase prices in
order to lift an economy out of depression.
Instruments / tools of reflationary policy.
 Tax reduction to increase purchasing power and demand for goods.
 Increase in government expenditure e.g subsidization of producers.
 Increasing wages of workers to boost their purchasing power.
 Encouraging exports by reducing export duty.
 Use of expansionary monetary policy.

3. Deflation:
This is persistent decrease in general prices of goods and services in an
economy.
Tools of deflationary policy include:
 Reducing government expenditure
 Using a restrictive monetary policy
 Increase in taxes
2|ECON NOTES BY A.N
  Reducing wages.
4. Disinflation:
This is economic situation where general prices fall due to planned anti
deflationary measures. General prices fall without decline in output or
employment.
5. Expectation inflation:
This is a rise in general price level brought about by speculation. In this
situation sellers hoard commodities expecting better prices in future which
in turn increases the general price level.
6. Anticipated inflation:
This is a situation of increase in the general price level where people expect
higher increase in general prices in future.
Or a situation in which there is persistent increase in general price level due
to firms expecting prices to increase again in future. (Speculative inflation)
7. Indexation:
This is the method of controlling effects of inflation where all forms of
incomes or payments are adjusted upwards so as to cope with the level of
inflation/rising cost of living.
8. Open inflation:
This occurs when markets of goods and services are allowed to operate
freely, setting prices for commodities without government intervention.
There are no checks / controls of commodity prices and distribution of
commodities. Open inflation later leads to hyper inflation.
9. Suppressed inflation:
Is a situation where aggregate demand exceeds aggregate supply but the
effects of general price increase are minimized by government price controls
and rationing.
Indicators of suppressed inflation in an economy.
 Price control and rationing of goods.
 Hoarding of goods and services.
 Black marketing i.e selling of commodities illegally at high prices.
 Increase in waiting lists in the labour market.
 Public queuing of scarce resources.
 Increase licensing by the government.
Effects of suppressed inflation
3|ECON NOTES BY A.N
  Leads to misallocation of resources
 Leads to rising levels of unemployment
 Promotes trade malpractices e.g smuggling of goods.
 Discourages investments in the country.
10.Headline inflation:
This is the increase in the general price level in an economy caused by
mainly increase in food prices. This inflation has direct bearing on the cost
of living.
11.Underlying inflation:
This is increase in the general price level of mainly consumer goods
excluding increase in food prices.

CLASSIFICATION OF INFLATION.
Inflation can be classified into two major forms.

a. According to the state/ degree of intensity. The state of inflation refers to

the speed or the rate at which the general price level of goods and services
increases.
Under this, the following can be noted;

(i) Mild /gradual/creeping inflation

This is the type of inflation which occurs when the rise in the price level is
too slow usually less than 10% and at times it may not even be noticed by
the public.
Or it’s where the persistent increase in general price level is at a slow /low
rate usually less than 10% per annum or one digit inflation.
It is regarded as a good state of inflation because a small rise in the prices of
goods and services encourages the producers to increase production since
the costs of production are low .i.e slight increase in prices acts as an
incentive to producers.

(ii) Hyper /galloping /runaway inflation

4|ECON NOTES BY A.N
 This is a type of inflation where the general price level of goods and
services increases at a very high rate in an economy. It’s usually more
than one digit inflation i.e. above 10% per annum .It occurs within hours,
days or weeks. It can be easily recognized by the public and it is
dangerous to an economy because it disorganizes production as the costs
of production tend to increase at a very faster rate.

b. According to the causes.

(i) DEMAND PULL INFLATION

This is the type of inflation which a rises out of excess aggregate demand over
aggregate supply at full employment of resources.
Or is a type of inflation which occurs when aggregate demand for goods and
services exceeds aggregate supply at full employment of resources which
results into price levels being pulled upwards in an economy.
It mostly occurs in economies which are at or near full employment level of
resources such that excessive demand for goods and services cannot be satisfied
by the existing level of output.

Price S

P2

P1 E
Agg dd2
S

Agg dd1
0 Q1 Q1 output

From the illustration, aggregate demand and supply are at equilibrium at point E
with price P1 and quantity Q1. An increase in aggregate demand for goods and
services leads to a shift in aggregate demand from aggregate dd1 to aggregate dd2.

5|ECON NOTES BY A.N

However any further increase in demand beyond aggregate dd 2 causes demand pull
inflation since an economy has already attained full employment level of
resources.

CAUSES OF DEMAND PULL INFLATION.

1. An increase in the wage levels of the workers, this makes their disposable
incomes high thus enabling them to demand for goods and services highly
thus leading to demand pull inflation.
2. Decrease in the level of direct taxes, reduced direct taxes on peoples income
and property increase the disposable income and purchasing power of the
people leading to demand pull inflation.
3. Excessive issuing of currency by the central bank, this increases the volume
of money in circulation leading to demand pull inflation.
4. Increased capital inflows. This money inform of aid, grants increase the
quantity of money in circulation which leads to an increase in the demand
for goods and services causing demand pull inflation.
5. Excessive government expenditure especially the recurrent expenditure. This
increases amount of money in circulation leading to demand pull inflation.
6. Increased foreign exchange earnings e.g. through increased exports. This
also increases aggregate demand for goods and services in an economy.
7. Increasing demand for exports in the foreign market, this increases the level
of foreign exchange from exports leading to increase in quantity of money in
circulation hence demand pull inflation.
Or increased demand for exports especially essential goods creates shortage
in domestic market which in turn leads to increase in prices.
8. Rural urban migration leading to increased demand for goods and services in
urban areas.
9. Uncontrolled credit creation by commercial banks using expansionary
monetary policy, this increase the quantity of money in the hands of the
public.
10. Hoarding of essential goods which causes further scarcity hence excess
aggregate demand over aggregate supply.
11. Increasing population growth which leads to increase in
consumption/aggregate demand ceteris paribus
MEASURES OF CONTROLLING DEMAND PULL INFLATION
6|ECON NOTES BY A.N
1. Wage freeze, deliberate holding of wages at their existing levels for a
specified period of time in order to limit wage increase hence limiting
increase in aggregate demand.
2. Discouraging rural urban migration so as to reduce the excessive demand for
goods and services in urban areas.
3. Increasing the level of direct taxes so as to reduce the people’s disposable
income and thus reduce aggregate demand for goods and services.
4. Reduction in government expenditure especially on non productive
celebrations hence reducing money supply and aggregate demand.
5. Use of a restrictive monetary policy; for example use of the open market
operation (OMO) , the increased bank rate so as to control the amount of
money in circulation hence reducing aggregate demand.
6. Encouraging saving habits among the people so as to reduce their
consumption habits and reduce on the aggregate demand of goods and
services.
7. Use of price control measures. Government can fix maximum prices for
essential commodities so as to control persistent increase in the general price
level.
8. Controlling monopoly tendencies such that there can be an increase in
output levels so as to meet the demand of goods and services.
9. Increasing imports of the essential goods to supplement the domestic
production and cope with increase in aggregate demand.
10. Use of population control measures like use of family planning methods to
control population growth rate hence limiting excess aggregate demand.
11. Trade liberalization, this increases supply of goods because producers are
given freedom to engage in various commercial activities without
government intervention.

(ii) COST PUSH INFLATION

This is a type of inflation which occurs due to increased costs of factors of
production which forces sellers or producers to push the prices of goods and
services upwards in order to enable them cover up for the costs incurred thus
causing inflation.
Or is one that arises due to increasing cost of production.

7|ECON NOTES BY A.N

 It originates from the supply side and it may take any of the following
forms:
1. Price wage inflation
This is persistent increase in the general price level due to increase in prices
which causes workers to demand for higher wages. This causes further
increase in prices due to increased cost of production/labour.

2. Wage price inflation

It refers to inflation which occurs when workers through trade unions
advocate for wage increments which forces the producers to increase the
prices of goods and services in order to cover up for the costs incurred and
when the prices are increased the workers again request for wage increments
because of an increase in the cost of living and the situation continues over
and over again.
Or a situation there is rise in prices due to increase in wages.

3. Wage – wage inflation

This refers to persistent increase in general price level due to inter firm or
sectoral comparisons of rise in wages. An increase in wages in one firm or
sector leads to demand for wage increase in another firm or sector with
similar economic activities. This results into increase in commodity prices in
economy due to increased cost of production.

4. Profit-push inflation.
It’s the persistent increase in general price level due to greed or desire for
profits by traders.
Or a situation that arises due to firm’s desire to earn abnormal profits hence
increase in cost of production and prices. This is common with monopoly
and oligopoly firms which restrict output and increase prices so as to earn
abnormal profits.
5. Raw material - push inflation.
Is inflation which occurs due to the increase in the cost of raw materials
which forces the producers to charge higher prices for their commodities
thus leading to inflation in the long run.

8|ECON NOTES BY A.N

 When producers use expensive raw material, output prices also increase
hence raw material-push inflation.

Note: Inflation spiral/cyclic inflation, this is the natures of inflation where

there is continuous repetition of factors that bring about increase in the
general price level s illustrated below

Increase in factor prices

Demand for higher wages

Increase in wages Increase in product prices
(Increase in cost of production)

CAUSES OF COST PUSH INFLATION

1. Increase in costs of raw materials and other factor inputs which forces the
producers to cover up for the costs by charging higher prices for their
commodities.
2. Increasing demand for higher wages and salaries by the workers. This
increases the production costs thus making the producer to reflect the costs
in the prices of goods and services.
3. Rising tax rates (indirect taxes) imposed on the values of commodities
especially at each stage of production e.g VAT.
4. Rising transport cost due to rising prices of fuel
5. Increase in interest rates of borrowed capital. These forces the producer to
charge high prices for his commodities in order to cover up for the high rates
paid when borrowing the money.

9|ECON NOTES BY A.N

6. Rising cost of advertising, this is incurred especially where the commodity is
persuasively advertised in the market.
7. Rising cost of rent for the premises used to produce goods.
8. Rising cost of power especially hydro electricity power.
9. Excessive desire for higher profits by the producers which makes the
producers to charge higher prices for their commodities.

MEASURES TO CONTROL COST PUSH INFLATION.

1. Provision of subsidies to the producers so as to reduce on the production
costs especially those dealing in essential goods.
2. Use of price control measures for example government fixing minimum
prices for inputs and commodities so as to keep prices stable.
3. Providing investment incentives e.g offering of tax holidays to the producers
so as to reduce on the production costs which increases local production.
4. Wage control measures to be put in place i.e fixing wages for workers in
order to reduce on the unnecessary wage increments.
5. Controlling the level of interest rates on loans so that producers find it cheap
to borrow for productive activities.
6. Use of rent controls as to reduce the cost of commercial rent.
7. Controlling private monopoly firms so as to minimize price increase.
8. Controlling trade union activities so as to control wage increase.
9. Use of non monetary terms of payment to labour for example payment in
kind.
10. Improving on the transportation network in an economy so as to reduce on
the transportation costs.

(iii) STRUCTURAL /SCARCITY /BOTTLE-NECK INFLATION.

This is persistent increase in the general price level due to supply rigidities
and structural bottlenecks in the sectors of the economy.
It also refers to type of inflation which arises due to structural rigidities in an
economy which causes shortages in the supply of goods and services thus
leading to an increase in their prices.

10 | E C O N N O T E S B Y A . N
 CAUSES OF STRUCTURAL INFLATION
1. Break down of key industries. This leads to limited supply of industrial
products which causes their prices to go up because of the high competition
for them.
2. Scarcity of raw materials necessary for production of goods and services,
this can be attributed to exhaustion of natural resources.
3. Political instability in an economy, this disrupts production thus leading to
low supply /scarcity of some essential commodities and thus high prices
because of the excessive demand for them.
4. Natural hazards such as floods, drought etc causing failure in agricultural
sector hence decline in supply of agricultural products.
5. Break down of infrastructure which leads to low productivity making
transportation of goods from one place to another difficult.
6. Shortage of foreign exchange, this is due to poor export sector and low
capital inflow leading to decline in supply of essential goods.
7. Hoarding of goods by traders through speculation hence causing temporally
shortage of commoditities.

SOLUTIONS TO CURB DOWN STRUCTURAL INFLATION

1. Developing infrastructures, so as to ease transportation of goods and services
from one area to another which facilitates production and supply of goods in
all sectors of the economy.
2. Modernizing agricultural sector, so as to reduce on dependence on natural
factors e.g adopting irrigation schemes.
3. Ensuring political stability so as to encourage production thus increasing on
the supply of essential goods and services.
4. Establishing industries in all parts of the country so as to increase the
production and supply of industrial products.
5. Provision of productive inputs for example through importation of raw
materials from cheaper sources so as to facilitate production of goods and
services.
6. Encourage private local and foreign investments/economic liberalization to
increase on productivity.

11 | E C O N N O T E S B Y A . N
(iv) MONETARY INFLATION
This is a type of inflation which arises due to increase in money supply
which is not backed by a corresponding increase in production
It occurs when the central bank prints more money to finance budget
deficits. This increase in money supply, increases aggregate demand of
goods and services which results into increase in general prices of goods and
services.
Solutions to monetary inflation
1. Using restrictive monetary policy e.g increasing bank rate or selling treasury
bills to the public.
2. Using wage freeze i.e deliberate holding of wages at their existing level at
specified period of time to limit wage increase.
3. Use of currency reforms so as to reduce money in circulation.
4. Increasing direct taxes so as to reduce people’s disposable income.
5. Reducing borrowing from central bank by commercial banks.

Circumstances where the increase in money supply may not necessarily

lead to inflation and they include
Qn. Explain the circumstances under which increase in money supply may
not necessarily lead to inflation.
The following are the circumstance under which increase in money supply
may not lead to inflation.
1. When increase in money supply is followed by a corresponding increase in
the supply of goods and services. In this case the increase in money supply
is used to transact additional output.
2. When there is high liquidity preference, when there is high liquidity
preference, money can be hoarded ie withdrawn from circulation.
3. When the marginal propensity to save is high, such that additional money in
circulation is set aside (saved) for future use.
4. When the restrictive monetary policy perused by government is effective
and can control the quantity of money in circulation.
5. When there is an effective price control system in an economy i.e maximum
price legislation which keeps prices stable.
6. When the increase in money supply is directed towards the purchase of
capital goods which do not influence price increase directly.
12 | E C O N N O T E S B Y A . N
7. When there is increase in direct taxes which can control disposable income
hence no increase in aggregate demand.
8. When there is income inequality in the economy i.e where a large proportion
of money is in the hands of the rich people whose marginal propensity to
consume is low.

(v) IMPORTED INFLATION

This is the type of inflation which arises from either import shortages or
importation of goods and services from inflation prone countries (those
already experiencing inflation).
It originates from outside an economy and it causes domestic prices of goods
and services to rise.
The imported goods/ inputs may include: machinery, raw materials,
petroleum products, skilled labour etc which are used in production of goods
and services.

Causes of imported inflation

1. High production cost due to increase in fuel prices
2. Increasing cost of transportation, insurance, and licensing of goods from one
country to another.
3. Protectionism against imports ie increase on tariffs on goods entering the
country.
4. Importation of goods and services from countries already experiencing
inflation
5. Increasing exchange rates which increase the cost of importation.
6. Importing goods from oligopolistic and monopolistic firms which normally
charge high prices.

SOLUTIONS TO IMPORTED INFLATION

1. Adoption of an import substitution strategy in order to produce goods that
were formerly imported from other countries to reduce the volume of
imports.
2. Restricting imports by only giving licenses to those importing essential
commodities only so as to limit importation of expensive commodities.

13 | E C O N N O T E S B Y A . N
3. Using international commodity agreements so as to stabilize prices of
imports and exports.
4. Subsidizing importers especially those dealing in importation of essential
goods.
5. Reducing invisible costs e.g transport cost, insurance premiums, handling
charges etc.
6. Importing goods from countries which are free from inflation.

NB: Theories of inflation are basically the source of inflation e.g. demand
pull theory of inflation; cost push theory of inflation, structural theory of
inflation e.t.c.

GENERAL CAUSES OF INFLATION.

1. Excessive government expenditure on non productive ventures and
celebrations like heroes day, Labour Day e.t.c and on salaries which
increases money supply in the economy hence increase aggregate demand
and inflation.
2. Political instabilities which disrupt production in many sectors of the
economy leading to shortages of goods and services thus bottle neck
inflation.
3. Greed for higher profits by the business men/traders in the short period of
time which forces them to fix higher prices for their goods and services in
order to realize abnormal profits hence rising prices..
4. Rising prices of the petroleum products in the country, this causes an
increase in the transportation costs thereby leading to an increase in prices of
factors of production and thus cost push inflation.
5. Increasing capital inflow from other countries, when foreign currency is
brought into a country, it’s converted into local currency which increases
money supply hence increase in aggregate demand and inflation.
6. Depreciation of the local currency ,declining value of local currency in
relation to other currencies makes the cost of importing goods high this
forces importers to increase the prices.
7. Rapid population growth rates. Rapid population growth rates increases
aggregate demand for goods and services hence inflation.
14 | E C O N N O T E S B Y A . N
8. Increasing costs of production. High costs of raw materials and
transportation costs incurred during the production process leads to high
prices for goods and services hence inflation.
9. Excessive exportation of essential creates shortages in the domestic market
causing a rise in prices.
10. Frequent wages and salary increments by government for the civil servants.
This increases the incomes of the workers thereby leading to increased
aggregate demand for goods and services hence inflation.
11. Excessive borrowing from the central bank by government and commercial
banks which increases money in circulation hence leading to inflation.
12. Increasing importation of goods and services from countries experiencing
inflation. This results increase prices of goods and services in domestic
market hence causing imported inflation
13. Supply rigidities. This is as a result of break down in the key sectors of the
economy and may be as a result of natural factors like pests and diseases,
floods especially for the agriculture sector.
14. High level of speculation by business men /traders and consumers where
some goods are hoarded hence causing scarcity.
15. Excessive printing of money by the central bank/uncontrolled credit creation
by the central bank which increases money supply hence increase aggregate
demand.
16. Break down of infrastructures ,such as roads, power sources, industries etc.
this makes the production process difficult thus reducing supply of goods
hence increase in general price level

SOLUTIONS TO CURB DOWN INFLATION.

1. Use of a contractionary/restrictive monetary policy. e.g increasing bank rate
and selling securities to the public, this reduces money in circulation and
aggregate demand hence controlling inflation.
2. Reducing government expenditure, this reduces expenditure on less
productive sectors or unproductive functions hence reducing money in
circulation.
3. Use of price control measures most especially fixing prices for essential
commodities. This helps to keep prices stable and thus reduces inflation in
the long run.
15 | E C O N N O T E S B Y A . N
4. Further privatization of state enterprises. This is aimed at, efficiency which
increases the level of output in an economy leading to reduction in general
price level.
5. Adoption of the production import substitution industrial strategy, this
involve producing formerly imported goods which minimizes inflation.
6. Discouraging exportation of essential goods so as to minimize shortages in
domestic market thus reducing inflation.
7. Infrastructural development, which helps in reducing production bottle necks
so as to increases on the production of goods and services to match with the
increasing demand for them.
8. Subsidization of the local producers’ e.g giving tax holidays. This reduces
the costs of production thus leading to low prices for goods and services and
thus reducing or controlling cost push inflation.
9. Importing essential goods from cheaper sources i.e from friendly countries
this reduces scarcity of such goods at home hence stabilizing the price level
thus curb down imported inflation.
10. Reduce government and commercial banks borrowing from the central bank
so as to reduce excessive money in circulation.
11. Creation of a stable political climate , this gives confidence to both local and
foreign investors thus encourage the production of goods and services so as
to enable the supply of goods and services to match with the demand for
them.
12. Reduce indirect taxes on essential commodities, so as to make them
affordable to consumers.
13. Modernization of agriculture i.e transforming from low value subsistence
production to high value production, so as to increase output and reduce
excessive aggregate demand.
14. Controlled printing of money. In order to reduces money supply in an
economy hence leading to reduced aggregate demand for goods and services
and inflation in the long run.
15. Liberalization of the economy i.e removal of any unnecessary control on
trade. This encourages production from various sectors leading to increased
output hence reduction in general price level.

16 | E C O N N O T E S B Y A . N
EFFECTS OF INFLATION
The positive effects/reasons why mild inflation is desirable.
Positive effects of inflation are associated with mild inflation since it is the one that
encourages production and they include;
1. Mild inflation promotes forced savings. During inflationary period people
receive income whose purchasing power is weak, they are forced to take up
savings for future investments thus leading to the growth of the economy.
2. Helps to pull an economy out of a depression. This is because increase in
money supply increases aggregate demand causing an economic recovery.
3. Stimulates investment and production in an economy, and this is because of
increased profits earned by the business men which is an incentive to
investment and production.
4. Stimulates hard work, mild inflation stimulates people’s effort to work
harder so as to cope with rising costs of living.
5. Creates employment opportunities, because it encourages entrepreneurs to
establish more investment so as to earn high profits from rising prices hence
job creation.
6. Promotes increased resource utilization, due to inflation, idle resources are
exploited so as to earn profits hence minimizing underutilization.
7. Promotes industrialization, inflation may force the country to establish
import substitution industries in order to avoid importation of goods from
inflation prone countries thus industrialization of the economy.
8. Encourages innovativeness and creativity, during inflationary period
entrepreneur becomes innovative in order to cope with rising cost of living
which eventually promotes technological development.
9. Borrowers or debtors gain during inflation, inflationary periods borrower
tend to benefit in real terms because they pay back money to lenders which
has low value than what they borrowed.
10. Provides government revenue,, government imposes taxes on peoples
incomes in order to fight inflation and this increases the level of government
revenue from taxation
11. Encourages mobility of labour, this results in to labour efficiency hence
increase in quality and quantity of products produced.
12. Stimulates production more so during times when producers produce at
excess capacity and this is because of the increase in the aggregate demand
17 | E C O N N O T E S B Y A . N
 for goods and services. This in the end leads to optimum utilization of
resources and economic growth at large.
13. Helps to monetize the economy, inflation as a result of increase in money
supply, increases the use of money in economic transactions which
eventually reduces the size of subsistence sector.
14. Helps to reduce the Balance of payment problems of an economy and this is
because mild inflation stimulates production which can in the end lead to an
increase in the volume of the country’s exports.

QN.
Under what circumstances may inflation be desirable in an economy?

NEGATIVE EFFECTS
1. Discourage investment, High rates of inflation discourages since the costs of
production are always very high and this leads to shortages of goods and
services in an economy.
2. Makes planning difficult, this is due to unpredictable changes in the cost of
production due to loss of money value as result of rising prices.
3. Discourages savings, high inflation discourages people from savings with
financial institutions due to constant loss of money value.
4. The government becomes un popular, due to inflation , the nationals tend to
lose confidence in the local currency due to constant loss of money value
and this eventually erodes the popularity of the government.
5. Leads to capital out flow as people tend to invest in other countries that
experience low rates of inflation.
6. Promotes income inequality, inflation promotes uneven distribution of
income between consumers who make the use of expensive goods and the
producer goods.
7. Leads to unemployment, inflation creates unemployment problem because
some inefficient firms collapse due to higher cost of production thus
rendering workers in such firms jobless.
8. Reduces production, potential investors/producers are discouraged due to
higher cost of production which forces firms to produce inferior goods
leading to low standard of living/ low consumption.

18 | E C O N N O T E S B Y A . N
9. Strains people to over work, people have to work for longer hours in order to
earn higher wages so as to cope up with the high costs of living due to the
high prices of goods and services.
10. Leads to brain drain, high inflationary rates tend to force the locally trained /
skilled labour to leave the country for other countries in search for better
payment hence shortage of skilled labour in the economy (stagflation).
11. Leads to industrial unrest, inflation promote industrial unrest due to
constant demand for higher wages by employees /workers to meet the rising
cost of living.
12. Worsens balance of payment problem, inflation makes exports expensive
leading to a fall in foreign exchange from exports due to low demand for
them yet the demand for expensive imports rises causing B.O.P problem.
13. Discourages lending / creditors lose, during inflation periods, lending is
discouraged since creditors/lenders tend to make losses because they get
back money from debtors/borrowers which has lost value/low purchasing
power.

QN.
Under what circumstances may inflation be undesirable in an economy?

RELATIONSHIP BETWEEN INFLATION AND UNEMPLOYMENT

1. At high rates of inflation, saving and investments are discouraged thus
causing unemployment.
2. High rates of unemployment lead to low levels of production which may
lead to inflation in case the demand is high.
3. High levels of inflation may force workers to demand for higher wages from
their employers which may make them adopt capital intensive techniques of
production thus leading to technological unemployment.
4. Fighting unemployment through an expansionary monetary policy increases
the amount of money in circulation thereby increasing aggregate demand for
goods and services thus inflation.
5. Both inflation and unemployment lead to brain drain in an economy which
in the end leads to labour shortages.

19 | E C O N N O T E S B Y A . N
6. They both lead to low standard of living in an economy since they increase
costs of living.
7. They may both cause unpopularity to the government in power because they
may generate social unrest and political instabilities.
8. May both lead to income inequalities in an economy i.e. between the rich
business men that charge higher prices for goods and services and the
unemployed (consumers).

END

20 | E C O N N O T E S B Y A . N