Discuss in detail the measures to combat demand-pull and/or cost-push inflation (Inflation). There are four main drivers behind inflation. Among them are cost-push inflation, or the decrease in the aggregate supply of goods and services stemming from an increase in the cost of production, and demand-pull inflation, or the increase in aggregate demand, categorized by the four sections of the macroeconomy: households, business, governments, and foreign buyers. The two other contributing factors to inflation include an increase in the money supply of an economy and a decrease in the demand for money
Cost-push inflation means prices have been “pushed up” by increases in the costs of any of the four factors of production—labor, capital, land, or entrepreneurship—when companies are already running at full production capacity. Companies cannot maintain profit margins by producing the same amounts of goods and services when their costs are higher and their productivity is maximized
Demand-pull inflation occurs when there is an increase in aggregate demand, categorized by the four sections of the macroeconomy: households, businesses, governments, and foreign buyer
Discuss in detail the measures to combat demand-pull and/or cost-push inflation (Inflation)
INTRODUCTION
COST PUSH
Inflation is a sustained and significant increase in general price level over a period of time and a simultaneous decrease in the purchasing power of money.
Accept any other relevant introduction. 🗸🗸
[Max 2]
BODY: MAIN PART
Causes of cost-push inflation
Increase in Wages:
- In South Africa, increase in wages constitute more than 50% of Gross Value Added at basic prices 🗸🗸
- If the increase in wages is not accompanied by an increase in production, the cost of production will rise 🗸🗸
- Producers will increase the prices of their products to offset the high cost of production strikes and stay-aways / labour union activities 🗸🗸
Key inputs/ increase in prices of imported capital goods
- When the prices of key inputs that are imported increase, domestic cost of production 🗸🗸
- increases especially in the manufacturing sector 🗸🗸
- Supply shocks e.g. sudden increase of oil causes a knock-off effect 🗸🗸
Exchange rate depreciation
- A decrease in the value of the rand will result in an increase in prices of imports 🗸🗸
Profit margins
- When firms increase profit margins, the prices that consumers pay also increase 🗸🗸
- Sometimes firms use their market power to push up prices 🗸🗸
Productivity
- Less productive factors of production will lead to increased cost per unit 🗸🗸
- Strikes and stay-aways often reduce production output and can result in price increases 🗸🗸
Natural disasters
- Natural disasters such as drought, flood and global warming can impact on the cost of production 🗸🗸
- This is often the case in relation to food prices 🗸🗸
Interest rates
- An increase in interest rates results businesses paying more money for capital loaned firms recover these costs by increasing the prices of their products 🗸🗸
Increase in taxation
- Increase in direct tax like company income tax may lead to businesses increasing their prices to offset the extra burden 🗸🗸
- Increase in indirect tax such as custom duty will lead to increase in costs of supplying a particular product, therefore the price will increase 🗸🗸
- Administered prices increase e.g. fuel prices
- Shoplifting and losses caused by employees are added to the prices of products 🗸🗸
[Accept any other relevant fact. Maximum 8 marks for headings]
[Max. 26]
DEMAND PULL INFLATION
Total spending on domestic goods and services in the economy consists of the spending by households, firms, the government and the foreign sector.
- Total spending = C + I + G + (X-M). 🗸🗸
Causes of demand inflation
Increase in consumption [C] – consumers expenditure will increase mainly for three reasons:
- a. If consumers save less & spend more🗸🗸
- b. Decrease in personal income tax. 🗸🗸
- c. A greater availability of consumer credit, because of decrease in interest rate. 🗸🗸
Investment [I] –When business invest this increase demand for labour, cement, sand and bricks. 🗸🗸
- Supply cannot keep up with the increase in demand and this will increase prices. 🗸🗸
- Lower interest rates may result in an improvement in the sentiment and profit expectations of businesses. 🗸🗸
- Businesses invest more and this may lead to an increase in the demand of goods and services that are part of the investment (for example, a new building requires cement bricks and labour).🗸🗸
- If aggregate demand increases at a faster rate than aggregate supply, price increases will follow.🗸🗸
Government Spending [G] – Three main reasons.
- a. New capital projects🗸🗸
- b. Consumption expenditure on education, health, and protection. 🗸🗸
- c. Social expenditure on public work programme to create jobs and increase in social allowances. 🗸🗸
Export earnings [X]
- a. When economy of trading country improve. 🗸🗸
- b. When global economy expands. 🗸🗸
Access to credit
- There is greater availability of consumer credit (by means of credit cards) of the availability of cheaper credit as a result of decreases in lending rates. As new credit is extended the credit multiplier kicks in and more credit is created. 🗸🗸
Consumption spending
- Most governments will at times increase expenditures on education, health, protection and safety (for example, military equipment such as bomber jets and submarines). 🗸🗸
Social spending
- Governments sometimes feel they have to do something substantive about unemployment and poverty. 🗸🗸
- They borrow money and spend it on public works programmes or raise the level of social grants year after year at a higher rate than the inflation rate. 🗸🗸
- Such expenditures invariably lead to inflation because they add to aggregate demand without adding anything to aggregate supply. 🗸🗸
Commodities demand
- The world’s demand for commodities expands and contracts like business cycles do. During an expansionary period, foreign demand increases and this leads to greater volumes of exports. The income earned from these exports adds to aggregate demand and prices increase. 🗸🗸
BODY: ADDITIONAL PART YES / NO
- Inflation targeting is when a particular percentage is set as an acceptable level for an increase in general price levels 🗸🗸
- The SARB’s inflation target is a range of 3% and 6% 🗸🗸
- The aim of inflation targeting policy is to achieve and maintain price stability 🗸🗸
- The implementation of the inflation target is easy to understand – expressed in numbers which makes it very clear and transparent 🗸🗸
- It reduces uncertainty and promotes sound planning in the public and private sectors 🗸🗸
- It provides an explicit yardstick that serves to discipline monetary policy and improves the accountability of the central banks 🗸🗸
- The SARB make use of monetary policy, specifically the repo rate to keep the inflation within the target range 🗸🗸
- The government make use of fiscal policy regarding public sector revenue and expenditure 🗸🗸
Positive effects
- Where demand is higher than supply an increase in interest rates help to bring the demand down 🗸🗸
- The policy can helps businesses to make economic plans without worrying about the effects of high inflation 🗸🗸
- South Africa’s price level has been fairly stable since the introduction of the inflation targeting policy in 2000 🗸🗸
Negative effects
- Inflation targeting can cause a reduction in economic growth 🗸🗸
- This is because the raising of interest rates, result in a decrease in total spending which is needed for production to increase 🗸🗸
- Decreased economic growth can increase unemployment 🗸🗸
- South Africa has been experiencing an increase in unemployment since the implementation of the policy in 2000 🗸🗸
- Inflation targeting is difficult to implement when the cause of inflation is supply shocks 🗸🗸
[Max. 10]
CONCLUSION
- Any relevant higher order conclusion that should include:
- A summary of what has been discussed without repeating facts already mentioned in the body. 🗸🗸
- An opinion or valued judgement on the facts discussed. 🗸🗸
- Additional support information to strengthen the discussion. 🗸🗸
- A contradictory viewpoint with motivation. 🗸🗸
- Recommendations. 🗸🗸
- E.g. Inflation can be a threat to the normal functioning of the economy; therefore, measures like monetary and fiscal are vital to keep the phenomenon under control. 🗸🗸