A second cause is rising global commodity prices, such as petroleum, copper, cotton or any standardized product that usually refers to a good produced in the primary sector. The sustained price growth in food sector. The increase in global commodity prices affects the aggregate supply curve in the same way as rising energy prices, as both are inputs in production.
Rising energy costs and commodity prices leads to a decrease in aggregate supply. An increase in the price of an input increases the cost of production. This means a decrease in profit margins for producers. As a result they will increase the price of goods and create inflation. This is shown by the leftward shift in the aggregate supply curve from AS to AS’. There is an increase in price level as shown by the shift from P to P’. A shift in the aggregate supply curve generates cost-push inflation.
However, the Bank of China argues that developed countries “will continue their loose policies and global liquidity will remain ample, which will keep prices of commodities, especially crude oil and grain, at high levels.”
One effect was “rush buying” after prices were reported. An expectation of the increase in prices lead to an increase in aggregate demand, which is the total demand for final goods and services in an economy at a given time period and price level. It affects the component of consumer expenditure. This is shown by the rightward shift in the aggregate demand curve from AD to AD’. Analysts said the news of price increases could exacerbate inflation concerns in China, especially among older consumers who suffered double-digit inflation in the 1980s.
In order to solve inflation, the central bank in China has said that “it has decided to use interest rates as a solution, by controlling excessive liquidity. It has raised benchmark interest rates three times since the start of last year.” The benchmark rate is the minimum interest rate investors will accept for investing in a non-Treasury security.
This is a contractionary monetary policy to control the growth of inflation, as interest rates can help to reduce the growth of aggregate demand, by increasing leakages and reducing injections. A higher interest rates will lead to a decrease in consumer expenditure as the cost of borrowing money becomes higher. Saving money also become more attractive, leading to more money being saved. This means that there is less liquidity in the economy.
Interest rates can be effective in influencing consumer spending in the short term as it directly influences the way people consider expenditure, since many people have mortgages or other type of loans. However, Interest rates have a time lag. It is estimated that it takes 18 months for interest rates to take effects, therefore it is hard to control inflation only through interest rates. Also some sections of the economy are not affected by high interest rates.
However, inflation can cause a reduction in the in the real value of savings, this means that the rate of interest does not compensate for the increase in general price level.
Additional Comments:
You could say that the government could employ supply-side policies. As in subsidize production, and train workers to improve their efficiency. This will increase AS and reduce price level.
LNOG TERM AND SHORT TERM
leakages have increased. growth of inflation
contractionary monetary policies
Define AS for more marks in one of the criteria (forgot which one!)
You can also say that it will reduce consumer spending. Consumer spending is a component of AD. AD = Consumer spending + Investment + Government Expenditure + Export – Import.
Hence, fall in consumer spending will cause AD to shift to the left. So, price level will go down.