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Research Proposal Title:: Effects of Inflation On Consumption of Our Society

The document is a research proposal that examines the effects of inflation on consumption in society. It begins with an introduction noting that inflation significantly impacts consumption patterns in developing countries like Pakistan by reducing purchasing power. The literature review then summarizes several academic papers that found both theoretically and empirically that inflation reduces consumption by increasing interest rates and decreasing the incentive to spend rather than save. The conclusion restates that inflation harms consumers in developing nations by worsening living standards as it drives up prices and squeezes purchasing power.

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Tooba Jabbar
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63 views5 pages

Research Proposal Title:: Effects of Inflation On Consumption of Our Society

The document is a research proposal that examines the effects of inflation on consumption in society. It begins with an introduction noting that inflation significantly impacts consumption patterns in developing countries like Pakistan by reducing purchasing power. The literature review then summarizes several academic papers that found both theoretically and empirically that inflation reduces consumption by increasing interest rates and decreasing the incentive to spend rather than save. The conclusion restates that inflation harms consumers in developing nations by worsening living standards as it drives up prices and squeezes purchasing power.

Uploaded by

Tooba Jabbar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Research Proposal

Title: Effects of inflation on consumption of our society

Submitted by: Muhammad Awais


Ayesha Habib
Muhammad Ahmed
Tuba jabbar
Submitted to: Mr. Mansoor Ali
Date: 5/23/2021
Chapter 2
Review of literature
Introduction: An arduous challenge in a developing country is estimating the
consumption patterns with increasing inflation. Whenever the general price level
increases it brings a drastic change in the purchasing power of a consumer and
theses effects are often considered enigmatic. Pakistan being a developing country
in the world also features the problem of inflation and the major portion of the
country that is the middle class it is highly effected by the capricious inflation
trends.
Whenever the general price level increases it negatively impacts the consumption
patterns of the consumers and thus it results in the aggravation of living standards
of the consumers. Consumption and inflation is correlated a common observation
is that the economics effects of both the variables get along with one another but
the question is the impact and the covariance among these two variables.
The prior researches in the history have shown a significant impact of inflation on
the consumption in a society and there is enough of theoretical and empirical
evidence related to this topic and the study has tried to gather enough of the
relevant information in this chapter.
2.1 theoretical literature
Francesco D’Acunto (2015).
The enigmatic determinants of consumptions are numerous. Consumption of a
household relies on the income. But in a household money is more aspiring and is
not limited to transaction motive.
Interest rate that depends on inflation is pretty much a temptation for a household
consumer which provides an incentive to save the income rather than consume it.
Ioana A. Duca (2016).
The dependent variable i.e., the consumption is elevated when people have an
incentive to spend rather than save. And as a result, aggregate demand increases.
According to this study an expected inflation lowers the real interest rate thus the
incentive to save decreases while increasing the spur to consume promptly.
Filip Premik (2017).
Consumption is dependent on income was theoretically explained by Keynes with
the passage of time and innovation it has been observed that consumption depends
on inflation and it also depends on the interest rate.
Inflation has a strong yet considerable impact on consumption. the relationship
between inflation expectations and consumption is inextricably linked to the
influence of the real interest rate on consumption. Because according to Fishers
equation real interest rate is equal to nominal interest rate minus expected inflation
rate.

Charles O. Manasseh (2018).


Many arguments support that the consumption solely depends on the income of
consumer. Conversely this study shows enough evidence to prove that the
consumption has other determinants like inflation and interest rate.
On the other hand, inflation is one of the major determinants of consumption.
Inflation decreases the purchasing power of individuals of society and thus
aggravates overall living standard of the nation.
2.2 Empirical literature
Luiz R.(2000)

A unifying framework to study consumption behaviour is provided by the


following conventional infinite-horizon representative agent set-up:

where:

r and ri are respectively the rate of time preference of the utility maximiser and the
rate of return on investment in asset i;
Et is the expectations operator at time t;

c(t) is private consumption;

W(t) is non-human1 private wealth;

si is the share of asset i in total private wealth.

Letting u[c(t)] = ln c(t), for simplicity, and taking account of the transversality


conditions, the rate of growth of consumption associated with problem (P) is:

Equation (1) is an Euler equation-type consumption function. If negative


consumption is to be avoided, the returns on assets holdings have to exceed the rate
of time preference of the utility maximiser (Hall, 1978, 1989; Turnovski, 1995).2

Using the intertemporal constraint in problem (P), private consumption can be


written as:

Taking time derivatives of both sides of equation (2) and recalling that, by
equation (1), private consumption can also be written as c(t) = qEt  (t), where q =
(Sisiri –r)–1, we obtain:

The expectation function on the RHS of equation (3) has solution Et[W*(t)] = W*(t),
for W*(t) = ert, such that c*(t) = qert = qW*(t), where r = åi siri. Optimal consumption
is then a fraction of permanent income or wealth, which grows at rate r.

Greg Kaplan (2016).


For any household i, the growth rate of expenditure x between quarters t and t + 4
is ln xi,t+4 − ln xit = ln πit,t+4 + ln qi,t+4 − ln qit (13) where πit,t+4 is a
household-level inflation rate and qt is an index of the real quantity consumed at
date t. Hence the cross-sectional variation in spending growth can be decomposed
as Var(ln xi,t+4 − ln xit) = Var(ln πit) + Var(ln qi,t+4 − ln qit) + 2Cov(πit, ln
qi,t+4 − ln qit).
Assume that the deviation of a household’s price level from the aggregate price
level consists of a household fixed effect plus an AR(1) process at an annual
frequency. That is, ln Pit − ln Pt = µi + ρ(ln Pi,t−4 − ln Pt−4 − µi) + it, (15)
where Pit is the price level of household i in quarter t, Pt is the aggregate price
level in quarter t, µi is a household fixed effect, and eit is i.i.d. across households
and over time with mean zero and variance σ 2 . Also assume that households’
initial conditions are drawn from the ergodic distribution, so that the distribution of
ln Pit − ln Pt is stationary, then Var(πit) = 2σ 2 /1 + ρ (16) and Cov(πit, πi,t−1) =
σ 2 ρ – 1/ 1 + ρ (17).
2.3 Literature related to Pakistan
MOHSIN S. KHAN (2006)
Inflation in Pakistan is increasing with every passing year and thus the consumption and living standard
of the population is decreasing. Inflation can boost the taxes but it can decrease the purchasing power of
the society which is not something people want in a country. Pakistan being a developing country has
meager amount of financial resources and a major portion of population can barely meet both ends. That
is why inflation is a curse for consumers. But on the other hand expected inflation increases the real
interest rate which attracts the savings and future investments.

2.4 Conclusion
For a developing country in the world, has a problem with inflation, and the
working class, which makes up the majority of the population, is particularly
vulnerable to fluctuating inflation rates. When the overall price level rises, it has a
detrimental influence on consumers' purchasing habits, resulting in a worsening of
their living conditions. Consumption and inflation are connected, and it's a frequent
conclusion that the political ramifications of both variables complement one
another. And interest rate plays a key role in the correlation of these two variables.

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