Who are the winners and losers of inflation and deflation?
Inflation is defined as a persistent increase in the average price level in the economy. This increase in the average price level causes a decline in the real value of money in the economy thus reducing consumer’s purchasing power. Economists have put forward three different types of inflation: excess monetary growth, cost-push inflation and demand-pull inflation.
The core theory regarding inflation relates to the supply of money. Monetarists believe that increases in money supply leads to higher aggregate demand, thus shifting the aggregate demand curve from AD 1 to AD2 causing the price level to rise from P1 to P2.
Demand- pull inflation is also the result of an increase in aggregate demand and can occur when the economy is near or reached full employment. An increase in aggregate demand to a level due to a change in any of the determents raises the average price level as the economy reaches full employment.
In contrast cost-push inflation is the result of increased costs in the factors of production such as wages and raw materials. The results of these changes are that firms cannot produce the same quantity as before and therefore the short-run aggregate supply curve shifts to the left from SRAS1 to SRAS2, thus causing the price level to rise from P to P1.
One of the government’s macroeconomic goals is a low and stable rate of inflation as there are many consequences of high levels of inflation. High levels of inflation rates are often followed by recessions when demand plummets.
Inflation affects people differently. The most obvious consequence associated with inflation is the consumers’ loss of purchasing power. Consumers who have fixed income experience a loss of purchasing power because as the average price level increases consumers real income falls. This means consumers can now purchase less than before with the same amount of money. Often when workers become aware of inflation they become unsatisfied with their current wages and request a raise in wages to cover inflation. Workers who are unsatisfied with their wages become less efficient or can strike. Less efficient workers and days lost through strikes have major implications on firms’ ability to supply goods and therefore firms will often grant their workers a raise in wages. This will increase costs of production and can cause a spiral of inflation with higher prices and higher wages.