Introduction to Inflation

Have you ever heard of the term "inflation" and asked yourself, aside from its literal meaning "to inflate something" what the term actually meant? Well, perhaps the term itself is somewhat foreign to some people, everyone should more or less understand what type of activity inflation is without hearing of the term.

To give you a simple understanding, some time in your life, you may have heard an older person talk about how different things were when he or she was your age. It only cost 65 cents to see a movie. Gas was 80 cents per liter. A brand new car only cost about RM12,000. As the years go on, prices have risen, sometimes drastically. Seeing a movie in the theater now costs about RM13; gas costs more than RM2.10 per liter; and few new cars cost less than RM50,000. and that my dear readers, is Inflation. 



According to FocusEconomics on Malaysia's rate of inflation, Consumer prices rose 0.84% over the previous month in September, which was well above the 0.09% increase tallied in August. The increase mainly reflected higher prices for transportation.

Inflation jumped from 1.9% in August to 2.6% in September, which was slightly above market expectations of 2.5%. The reading marks the highest level since January 2012. Annual average inflation ticked up from 1.6% to 1.7%.

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FocusEconomics Consensus Forecast panelists expect inflation to accelerate in the months ahead and to average 2.1% in 2013, which is unchanged from last month’s projection. For 2014, the panel sees inflation rising to 2.8%, which is up 0.1 percentage points from last month’s forecast.

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Note: Annual variation of consumer price index (CPI) in %.
Source: Department of Statistics Malaysia and FocusEconomics calculations.





With this information gathered above, we are going to explore several aspects of inflation, namely, to understand WHY inflation occurs, WHAT are the factors that affect the rate of inflation, HOW is the inflation rate calculated, WHAT are the effects of inflation, what is the GOVERNMENT doing to CONTROL the effects of inflation, and how inflation AFFECTS consumers' purchasing behaviour.



Conducting the survey was neither difficult nor simple, and our first obstacle was to decide WHO were our choices for candidates, after deciding to have a mix of students as well as working adults as our target candidates, we had to make sure the survey questions were structured in such a way as to be simple to understand yet complex enough to give sufficient data needed for our investigation 

Methodology

             In the course of doing this research we as a group have used both primary and secondary data as the basis of our findings. The method that we used to gather primary data was by doing a survey about inflation to the public. The survey was done at a few places including Taylor’s University and suriamas condominium, with most of the respondent being student. The data that we gathered are primarily about the term “inflation”, respondent’s view on the subject and also their prediction of what is going to happen to inflation in Malaysia in the near future.

            We also gathered primary data from trusted internet sources such as the official Department of Statistics Malaysia website other websites. We also gathered information from economics textbooks and magazine as a way to further educate ourselves in the topic of inflation as well as to expose ourselves to the economics of the country. The newly announced Malaysia budget for 2014 will also be discussed as it shows a glimpse of what is going to happen to the inflation of the country in the near future. We used a variety of information sources to reduce the chances of our findings to be biased and unaccurate.

Analysis on survey data

             As we mentioned before, we did a survey to collect responses and views from the public on our topic which is "inflation". The respondents for the survey that we carried out ranged from the age 17 to 65 but they mostly consisted of students.

            More than 85% of them knew what the term “inflation” meant before we conducted the survey. We answered the questions of respondent’s who didn’t know the topic to the best of our ability and the survey was conducted normally afterwards. From the results of all the survey, some of the data that we acquired is that most of them agreed that their spending will increase whenever an there is a positive rate of inflation in the country.

            Other than that more than 50% of the respondent believes that inflation has a good effect on the economy of a country, given that the rate is not too high, while 1/3 of the respondent disagreed with the statement and the others didn’t give any comment. On the other hand, we also gathered that majority of the respondent think that inflation is bad for the people, both consumer and producers.

            One last thing that is worth mentioning is that none of the respondent thinks that the rate of inflation of Malaysia will decrease or be stagnant in the coming 6 months.

Analysis on rate of inflation in Malaysia 2005 - 2012

From the data that we have gathered from world bank, we will data of Consumer Price Index (CPI) which can be used to calculate inflation in the country or region. We will use yearly CPI in Malaysia starting from the year 2005 until the year 2012 with the year 2005 as our base (100) for our analysis.

Year	Consumer Price Index	Inflation rate
2005	100.0	-
2006	103.6	3.60
2007	105.7	2.03
2008	111.5	5.49
2009	112.1	0.54
2010	114.0	1.69
2011	117.7	3.25
2012	119.6	1.61

As shown by the graph and table above, Malaysia has been constantly going through inflation at a fluctuating rate. Every year there will be an increase to the overall price of products in Malaysia with the highest being in the year 2008 with an increase of 5.49% in the CPI from the year 2007. This is due the hike in the price of petrol and oil which happened that year. This is followed by the smallest increase in the CPI the following year which is a rise of 0.54%. This can be read as the government taking action in controlling the rate of inflation in the country from the past year so that the value of currency is stable.

            It also seems that this trend will continue on. We say this because from the newly released Malaysia budget 2014, it seems that the government is trying to curb the rate of inflation, which means that Malaysia will continue to inflate, unless the government succeeds in it’s effort to curb it. The survey that we carried out for this research also shows that the public also thinks that Malaysia will continue to undergo inflation.

Causes of Inflation

Demand-pull inflation

(Tutor2u, 2013)

  The Short-run Aggregate Supply(SRAS) which moves upwards  from the left to the right shows that the national output of the sector’s firm increases as the general price level increases. However, the Long-run Aggregate Supply(LRAS )reaches a state of a vertical shape once the economy has achieved full employment.  Although the price increases, the national output is constant as the allocation of the factors of production is restricted.( Lai, 2013)

  Due to the rise in consumer demand, rise in the expenditures of the government, rise in firm’s investment or an increase for the people’s demand for the country’s export, the Aggregate Demand(AD) curve will shift to the right from AD1 to AD 2. (Vengedasalam and Madhavan, 2011)

  The intersection  of AD2 and LRAS determines the full employment aggregate output which is Y2. AD2 which exceeds the aggregate supply(AS) causes demand-pull inflation. In Keynes’s analysis, it is assumed that at full employment, aggregate demand exceeds aggregate supply. If the factors of productions are fully employed or utilized, the economy is trying to produce beyond its limit. Consequently, the price level is pulled upward due to the spending. The essence of demand-pull inflation is  that there is “too much money chasing too few goods”. (Vengedasalam and Madhavan, 2011)

Cost-Push inflation

Cost-push inflation is an increase in the level of general price which is related with an increase in production’s cost.  (Vengedasalam and Madhavan, 2011).The rise in price is the rise of per-unit production cost.( McConnel,Brue and Flynn, 2012) There are several factors which cause the shift of the Aggregate Supply(AS) curve:

(i)                  Profit-push inflation

If certain monopolists or producers push up prices by stocking up goods and creating an artificial shortage.(Vengedasalam and Madhavan, 2011)

(ii)                 Import-push inflation

Because of the hike of the rate of foreign exchange, there will be an increase of the prices of imported finished or raw materials. This will lead to an increase in costs of production. Consequently, there will be an increase in the price of outputs. (Vengedasalam and Madhavan, 2011)

(iii)               Wage-push inflation

The increase in the price of output and the production’s cost will result in the wage level and eventually will lead to wage-push inflation. (Vengedasalam and Madhavan, 2011)

(Economics HELP, n.d.)

  In the figure above,  the intersection of the Aggregate Demand curve(AD2) and the Short-run Aggregate Supply Curve(SRAS1) determines the equilibrium price which is P1 and the full employment aggregate output, which is Y1.Due to the shift in upwards of the Aggregate Supply curve from SRAS 1 to SRAS 2, the equilibrium price level rises from P1 to P2 while the aggregate output falls from Y1 to Y2. Cost-push inflation is the increase in the general price level. (Vengedasalam and Madhavan, 2011)

Method to Calculate the Rate of Inflation

The indication of the rate of inflation can be done through the calculation of the consumer price index(CPI), which is also named as the cost of living index. (Vengedasalam and Madhavan, 2011).To calculate the inflation rate, compute the change in percentage in the CPI from one year to the next. (Vengedasalam and Madhavan, 2011).

Inflation rate=[(CPI this year-CPI last year)/ CPI last year] X 100%

Effects of Inflation

Savings will be reduced

Deterioration and depreciation in the context of real income will happen to the values of paper assets or fixed deposits such as bonds and life insurance policies. (Vengedasalam and Madhavan, 2011; McConnell, Brue and Flynn , 2012) As the depreciation or deterioration of the value of fixed deposits will happen because of inflation, investment and savings in non-financial sectors, which includes lands, will be reduced. (Vengedasalam and Madhavan, 2011)

The pattern of the distribution of income will be changed

Groups of people who lose from continuous inflation:

(a) Creditors. This is because the real value of the money owed to them will be less. 

 ( Vengedasalam and Madhavan, 2011)    

(b) Fixed-Income receivers. This is because the real value of their income will be less.                    ( McConnell, Brue and Flynn , 2012)

(c) Savers. This is because the value in terms of real income of fixed deposits or paper assets will be less. (Vengedasalam and Madhavan, 2011)

Groups of people who gain or who are helped from continuous inflation:

(a) Debtors. This is because the real value of money they owe will be less.

 (b) Property owners. This is because property owners gain from the increased property prices because of inflation. (Vengedasalam and Madhavan, 2011)

Production will increased

As long as old stocks are held by producers, higher profits will be made by producers because of the rise in the general level of prices. Thus, the producers will be led to increase their production level. Consequently, the rate of unemployment will be reduced. (Vengedasalam and Madhavan, 2011)

What the government is doing to control the effects of inflation

            The government can control inflation by contraction fiscal policy, reducing spending and increase taxes during boom times. The goal of contraction fiscal policy is to close an inflationary gap, restrain the economy, and decrease the inflation rate. Contraction fiscal policy leads to a smaller government budget deficit or a larger budget surplus. When reducing taxes, it will affect the income and consumption to decrease as well as consumption is a part of AD.

            Another way that the government can control inflation is by contraction monetary policy, which is called as restrictive, or tight monetary policy. It is aim to achieve the ultimate economic objectives which are maintaining stability of domestic prices, eliminating fluctuations in productions and employment and achieving full employment. In monetary policy, it includes open market operation, required reserve ratio and discount rate. 

Consumer Purchasing Power when Inflation Occurs

When it comes to consumer purchasing power during inflation, it may not change much when purchasing essential goods and services as they are necessary to fulfill their needs. However, their behaviour when it comes to purchasing unessential goods will be greatly affected as they become more cautious about spending their money on desirable goods. in an effort to cut costs, some consumers are willing to try alternate brands of goods that offers the same type of product for a cheaper price. And consumers may also turn to using local goods instead of imported goods as local goods are usually much cheaper.

From our survey, 11 out of 15 said that they would look for alternative products during inflation

Taken from Federation of Virginia Food Banks at http://vafoodbanks.org/

An increase in inflation means an increase in the prices of goods and services, This will have an impact on the consumers' purchasing behaviour. The increase in inflation will affect the ability of the consumer to be able to purchase goods and services for a higher price or not. Inflation affects the value of money directly because as it increases, the value of money decreases, and so does the purchasing power of consumers. The effect of inflation on consumer behaviour is more severe when wage do not increase to accommodate the increase in prices (Lee, 2013)

From our survey, 8 out of 15 said that their expenditure does increase during inflation

Inflation and unemployment

             This analysis of the inflation and unemployment cycle is written under the assumption that people will generally spend more when their income increases .This assumption is supported with the result of our survey which shows that almost 70% of the respondent will increase their spendings when their income increase. Humans have unlimited needs and limited resources, so when their buying power increases they would spend it to satisfy their needs.

            When a country wants to grow, the government and the central bank will introduce new policies to promote growth in the country. Government’s effort can consist of activities such as increasing government spending on subsidies or development and decreasing fiscal policies. While the central bank can reduce the required reserve ratio imposed on other banks to increase money supply in the country.

            These propositions which promotes growth will also reduce percentage of unemployment as with the reduced tax and so on companies will take the opportunity to increase their productions and that will require more labour. When more people is working they will have more purchasing power which will result in high demand of products in the market, which will induce more productions and an increase in price of products. So this cycle of increasing prices, which is know as inflation because the amount of money increases but the value of it decreases, continues on.

            This will in turn cause the government to control inflation within the country as the value of their currency is dropping. In this situation the opposite of the first action is done, which is increasing fiscal policy, decreasing government spendings and the government can even sell bonds to other country. While the Central bank can impose a higher required reserve ratio on banks so that the money that they can loan to the public decreases. These actions will induce deflation or depression.

            When this occurs, the cost imposed on a company will increase and they would want to reduce their cost which leads to a reduction in their productivity. Less labour will be required and the rate of unemployment will increase. With the higher rate of unemployment and the tight monetary policy, consumers buying power will reduce and the demand for products will lessen which will cause a drop in the general price of goods.

 And this will be followed by the government’s action to promote growth again and the cycle continues on.

Conclusion

In conclusion, inflation is a phenomenon that affects everyone, regardless of social stature, age, country and so on. Coupled with the fact that our world's population continues to increase everyday while resources remain as scarce as ever definitely raises inflation rates.

The sum of our findings in this research, we can say that inflation is a natural occurrence, of the decreasing value of a currency, which happens because of the way people circulate money in the market. it also seems that inflation happens when there is growth in a country, although, too much of it is not good for the country's economy as well as the people as they are unable to buy more things even if the value of the money is increasing.

The Government of Malaysia and it's central bank is trying to cope with the increasing rate of inflation in the country by trying to reduce the margin of which inflation gradually increases. It is also kept in a cycle of minor inflation and deflation to stabilise it. The government can also implement subsidies, monetary policy, fiscal policy and goods and services tax in an effort to control the rate of inflation.

In an effort to control the inflation so that it does not get out of hand is, to educate the public about the causes and effects of inflation, as well as to keep them informed of the benefits and drawbacks of inflation as well, this may help in managing the rate of inflation with the efforts of the government and the central bank.

Reference list

Vengedasalam, D.  and Madhavan, K. ,2011. Economics. Kuala Lumpur:Oxford Fajar

Riley, G. (2010). AS Macro Revision: Demand Pull Inflation. [Online]. May 31st 2010. Available from: Tutor2u.net http://www.tutor2u.net/blog/index.php/economics/comments/as-macro-revision-demand-pull-inflation [Accessed 3rd November 2013].

McConnell, C.R. , Brue, S.L. and Flynn, S. M.,2012. Economics, 19th Edition. New York: McGraw-Hill/Irwin.

ECONOMICS HELP, n.d. Causes of Inflation. [online]. Available at: http://www.economicshelp.org/macroeconomics/inflation/causes-inflation/ [Accessed 3rd November 2013].

Chang, L.M. ,2013. Teks Pra-U STPM Ekonomi(Makroekonomi) Penggal 2.Kuala Lumpur: Pearson Malaysia

World bank data. Consumer price index (2005 = 100). [online]. Available from: http://data.worldbank.org/indicator/FP.CPI.TOTL [Accessed 6th november 2012]

Malaysia - Inflation: Find the latest economic news and forecasts for Malaysia, Inflation. 2013. Malaysia: Inflation | Economic news. [online] Available at: http://www.focus-economics.com/en/economy/charts/Malaysia/Inflation [Accessed: 8 Nov 2013].