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Discuss the economic consequences of inflation?

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Introduction

Discuss the economic consequences of inflation? In this essay the economic consequences of inflation on the economy will be considered. Inflation is a continuous rise in average price levels including wholesale and factor prices. There are two main causes of inflation; cost push and demand pull inflation. Cost push inflation occurs when the price level is pushed up by sustained increases in the cost of production which is independent of aggregate demand. Demand pull inflation occurs when price increases as a result from an excess of demand over supply. Firstly, high Inflation erodes the real value of people's savings. It transfers wealth from savers to borrowers. Unanticipated inflation causes arbitrary redistribution of wealth and incomes meaning any wealth that does not rise rapidly with inflation loses its real value. This happens when people do not predict inflation and fix index linked pay, prices and contracts. Secondly, inflation leads to people bringing forward their purchase to avoid higher prices. ...read more.

Middle

High inflation may be harmful to an economy as it results in a reduction in the price competitiveness of the economy in international markets. Exports will become relatively expensive and imports cheaper. This leads to the balance of payments suffering as consumers switch to cheaper substitutes. This creates a bad current account draining an economies foreign reserve. This creates a crisis as confidence in the currency decreases leading to an outflow of hot money causing the currency to collapse. In contrast if the rate of inflation is similar or lower than that of other countries then inflation can either have a positive or no effect. If inflation occurs at a higher rate then the European Union we cannot join as the European Union countries import over 60% of British trade. As we are one of the most importing nations it is vital our inflation rate stays below or at the world average. On the other hand the government benefits from extra revenues generated from inflation through Fiscal Drag. ...read more.

Conclusion

The Monetary Policy Committee responds to high inflation by imposing higher interest rates which have a negative effect on output and investment. On the contrary the economy benefits from low and stable inflation as there is greater macro economic stability and improved efficiency. Overall it can be concluded that the economic cost of inflation depends on four factors. Firstly, the degree of inflation as inflation is more costly if it is high and variable. Secondly, the costs are variable depending on whether inflation is anticipated by consumers and produces. Furthermore, the costs differ if inflation is greater in one country than in another to whom it trades. Finally, the costs are dependant upon whether the exchange rate adjusts to restore lost price and cost competitiveness for exporters. From this it can be argued that low, steady and predictable rates of inflation can be beneficial to an economy. This is because it increases consumer confidence and keeps a sufficient wage differential as incomes rise each year. Stable inflation also helps an economy grow and increase the revenue generated by the government. Inflation also promotes economic growth and increases a countries productive capacity. - 1 - ...read more.

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Here's what a star student thought of this essay

4 star(s)

Response to the question

This essay engages superbly with the question. Not only does it look closely at the consequences of inflation, but there actually is a discussion here, which is often missed out on an essay like this. I particularly liked the conclusion ...

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Response to the question

This essay engages superbly with the question. Not only does it look closely at the consequences of inflation, but there actually is a discussion here, which is often missed out on an essay like this. I particularly liked the conclusion where they use phrases such as "the economic cost of inflation depends on four factors" as it shows strong awareness that no situations are the same, and part of economics is identifying which factors are most significant. Some of the discussion could've been slightly longer, looking in detail to how each factor discussed can affect the consequences. Other than that, this essay would've picked up plenty of marks for evaluation.

Level of analysis

The analysis here is strong. Inflation is clearly defined in the introduction, and there is good understanding shown by talking about the causes of inflation. I liked this, as it gives a foundation to the essay without going off on a tangent to the question. Technical terms such as purchasing power are used confidently when addressing the costs of inflation. It was good to see a discussion of international competitiveness, as this is one of the more major costs which is often ignored. Although all of the costs are well explained, I feel the discussion could have been elaborated upon. There needed to be a discussion of the size of inflation, as it's clear a high level is more detrimental to the economy than a small level. The essay mentions anticipation and expectations, but this could've been elaborated upon. If inflationary expectations are high, it is likely that wages will be pushed up by workers, causing more wage-price spirals. Such further analysis would've pulled this essay into the top marks.

Quality of writing

The structure here is strong, with a clear introduction and a strong conclusion offering a justified judgement. I'm not a fan of the opening line as it doesn't seem sophisticated, and in an exam it just wastes time. Technical terms are used well, and I like the style here. Phrases such as "similarly" or "in contrast" and "depends upon" shows a good critical awareness of the costs in relation to each other. This strong style allows for a convincing argument, and spelling, punctuation and grammar are strong. A diagram or two may have secured this essay higher marks for analysis, possibly showing how inflation can result in further inflation.


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Reviewed by groat 23/03/2012

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