Business Economics Essay On Consumer Price Index.

Discuss about the Business Economics for Consumer Price Index.

Demand-pull inflation

Demand-pull inflation in an economy occurs when the aggregate demand increases more than the aggregate supply (Kawasaki, Yamaguchi & Yanagida, 2010). This inflation occurs as the overall economy grows on the other hand. In this situation, it is said that much money in the economy chases only a few available goods and services.  The increased aggregate demand results due to increased employment by firms in order to increase the output. A maximum point is reached in the economy where no more output can be produced to cater for the rising demand as all the factors of production are fully occupied/utilized. As a result, further increase in aggregate demand at the constant output supply shifts the aggregate demand curve from AD1 to AD2 hence raising the price from P1 to P2. This price increase is the demand-pull inflation and is illustrated in the diagram below:

Cost-push inflation

Cost-push inflation in an economy occurs when the aggregate supply of goods and services decreases. This occurs due to an increase in the production cost when the maximum productivity has been reached. High production costs at maximum production companies’ level makes the companies unable to realize profits. As a result the higher production costs are passed on to the final consumer hence increasing the price of goods and services and the aggregate supply curve shifts from AS1 to AS2 as the prices increase from P1 to P2. This is illustrated below:

Causes of demand-pull inflation

1. Future inflation expectations: expectation of future prices of goods and services to rise increases the aggregate demand as the aggregate supply decreases. As the aggregate demand outdoes the aggregate supply in the economy, the general price of goods and services increase leading to demand-pull inflation
2. Increase in consumer level of disposable income: As the consumer level of disposable income increases as a result of decreased government taxes and more money in the economy, consumer expenditure rises. This increases the aggregate supply in the economy which eventually raises the price of goods and services hence resulting to demand-pull inflation.

Causes of cost-push inflation

1. Wage rise: Trade unions may demand for increment in salaries paid to employees by companies.  The companies in order to achieve the increased wages and maintain their profitability may increases the general price of goods and services hence resulting to cost-push inflation.
2. Increased profit margin: companies may become more powerful and raise their profit margins so as to make more profits. This is mostly the case whereby the market moves towards monopoly or oligopoly markets. As a result the overall price of goods and services is raised resulting to cost-push inflation.

Advantages of using Consumer Price Index (CPI) to measure prices

1. The CPI enables the federal government to determine the extent for the adjustment of the social security and other programs funded by the government. CPI indicates the level of consumer’s income in a nation and hence enables the government to determine the level at which to assist its citizens by involving itself in consumer support programs.
2. CPI enables the determination of the level of inflation (Bryan & Cecchetti, 2013). A higher increase percentage in the annual level of CPI is an indication of higher level of inflation while a lower increase in the annual percentage of CPI indicates a lower inflation rate.

Disadvantages of using Consumer Price Index (CPI) to measure prices

1. CPI overstates the rate of inflation: when CPI is used to measure prices, it does not consider any improvements in the level of technology that may have occurred between different periods of time. As a result, the inflation rate shown may not be accurate.
2. CPI does not consider the quality of goods and services: an item included in the fixed basket of goods and services may change its quality. This is not reflected by the CPI and hence may give false information about the prices of the unmatched quality of goods.
4. A gain from inflation: some people particularly the producers can predict the future with great certainty. As a result they prepare to adjust for any future changes and hence end up being winners. The borrowers also benefit from inflation as they repay the borrowed funds at a lower rate of interest than the inflation rates.
5. A lose from inflation: some people particularly those who depend on fixed income such as the money lenders and fixed wage employees. The money lenders receive their borrowed funds from borrowers at lower rates of interests which are not adjusted for inflation. Fixed wage employees continue to earn their fixed salary irrespective of inflation rate and hence end up being losers.

The Australian measure of unemployment is considered to be absurd.  This means that the Australian real unemployment and under-employment is under-reported. For instance, more than 10% of the Australian population are under-employed yet considered to be employed. This inaccuracy in unemployment measurement has misled the Australian government and the reserve bank in making important economic decisions and needs to be addressed as soon as possible

1. G (Government Expenditure) is affected. A town council funding a new library increases the government expenditure and hence increases the GDP.
2. C (consumption) is affected. When the federal Government raises the tax free threshold, consumption increases due to increased consumer income and hence the GDP increases.
3. X (exports) is affected. Fewer tourists visiting Australia decreases the exports value hence decreasing the GDP.
4. M (imports) is affected. The increase in demand for domestically produced goods decreases imports consumption and hence increase the GDP.
5. I (investments) is affected. The purchase of banks’ bonds increases investment in the economy and hence increases the GDP.
6. I is affected. The borrowing of funds by manufacturing firms due to low interest to rates finance to finance the building of new factories increases investment and hence increases the GDP.
7. X is affected. Higher price for the Australian dollar by abroad customers reduces the purchase of its exports and hence reduces the GDP.
8. C, I, X and M are affected by tax reduction. Tax reduction increases consumption, investment and exports and reduces imports. This therefore increases GDP. Reduction of government expenditure affects G. it reduces the GDP.
9. C is affected. More savings by individuals reduces consumption and hence decreases the GDP.
10. X and M are affected. Trading partners recovering from recession reduces exports and increases imports. GDP is reduced.
11. Negative impact on public spending: the government may decide to reduce its expenditure in order to reduce inflation and improve GDP. This will adversely affect the nation’s public services such as the public transport and may end up causing problems in the market.
12. Time lags: the government may decide to adjust its spending depending on the set goals. However, this may take too long since government expenditure is determined only once per year.
13. Forecasting difficulties: fiscal policy depends much on accurate future economic forecasting (Blanchard & Leigh, 2013). The government if faced with false future forecasting information may make wrong fiscal policy decision which may adversely affect the country’s economy in future.

Frictional unemployment occurs as employees search for new jobs or as they move from their current job to another. A country with imperfect job information and non-zero job-search time adversely faces frictional employment. Employees may enter a job which they had no correct information about only to end up realizing it was not what they wanted. This makes them to continue searching for more correct job opportunities hence increasing frictional unemployment.

Macroeconomic policymakers should be concerned about structural unemployment which occurs due to a mismatch in skills that workers have and skills demanded by the industry. Structural unemployment can last for long if not well addressed hence prolonging unemployment rate in a country, even if recession ends. If an industry technology changes, workers should be trained to adapt to the changes rather than firing them. Structural unemployment differs from cyclical unemployment due to the fact it is caused by industry forces rather than business cycles (Wagner, 2014). Cyclical unemployment may end after recession period but structural unemployment can last for years if not well addressed.

1. The economy’s monetary base decreases. This is due to the fact that the money available in the economy is used in the purchase of the RM800 million government securities.
2. The short-term money market interest rates rise. The selling of the RM800 million government securities reduces money supply in the economy. As only little cash is available it outdoes the money demand in the overall economy and as a result short term interest rates increase (Axilrod & Wallich, 2009).

• The long-term maturity interest rates decrease. In future the Bank Negara will purchase the government securities at maturity interest rates in order to increase money supply in the economy. The long-term maturity interest rates will be low and consequently the rate at which money will be sold in the private money market will be low.

1. The aggregate demand and the economic activity decrease since only little cash in the economy is available for expenditure and investment. Inflation will also decrease as the aggregate demand decreases and hence commodities price in the economy decrease.

The economies monetary base in terms of the local currency decreases as the bank uses the local currency to purchase the RM800 million foreign currency. The domestic price rises. Much of the foreign currency will be available in the economy and as a result its demand will decrease and hence the exchange rates will decrease.

RM200 billion cut in taxes policy is more expansionary. Tax reduction influences the economy in numerous ways as compared to government expenditure. The tax reduction increases consumer level of expenditure as more money is available and also fosters investment in the economy. Tax reduction also reduces price of goods and services in the economy reducing the overall inflation. It also increases exports since they can be sold at affordable prices to customers abroad. Therefore due to various economic sectors which are influenced by tax reduction, a tax cut of RM200 billion is more expansionary.

References

Axilrod, S. H., & Wallich, H. C. (2009). Open-Market Operations. In Money (pp. 288-293). Palgrave Macmillan, London.

Blanchard, O. J., & Leigh, D. (2013). Growth forecast errors and fiscal multipliers. American Economic Review, 103(3), 117-20.

Bryan, M. F., & Cecchetti, S. G. (2013). The consumer price index as a measure of inflation (No. w4505). National Bureau of Economic Research.

Kawasaki, M., Yamaguchi, M., & Yanagida, T. (2010). Natural chaotic inflation in supergravity. Physical Review Letters, 85(17), 3572.

Wagner, B. (2014). Types of Unemployment. Montana Department Of Labour And Industry, Research And Analysis Bureau.