ECS 1601

Learning unit 9
Inflation

You have probably heard of

the word inflation before,
right?

Well, today you are going

to learn how it works!

Take out your text book. Keep

it next to you!
If the slide has a red
speech bubble that says
READ section so-and-so, hit
pause, read the section
and watch the slide
thereafter!

Remember, the
best way to learn
is to take notes
and ASK if you
dont understand.

Content
In this learning unit you will learn
more about:
The definition of inflation
Measurements of inflation
Effects of inflation
Causes of inflation
Conflict approach to inflation

Read section
20.1 in
textbook
pp 382

9.1 Definition of inflation

Inflation is the continuous and considerable rise in

prices in general
Please note the following regarding this definition:
1. The definition is neutral it doesnt give a possible
reason why prices are rising.
2. Inflation is a process it does not refer to a once-off
rise in prices
3. A very low level of inflation, such as 0,5%, should not
really even be defined as inflation there should be
a considerable increase in prices.
4. Prices in general should increase. If only the price of
one good, like the petrol price, increases this will
have an effect on inflation, but it isnt an example of
inflation.

Read section
20.2 in
textbook
pp 382-384

9.2 Measurement
of inflation

In this learning unit we are going to look at

three different measurements of inflation.
Each focuses on a different aspect of
inflation:
1. The consumer price index (CPI)
2. The producer price index (PPI)
3. The implicit GDP deflator

9.2 CPI
Recap from learning unit 5 page 246 of
textbook - how CPI is measured.
StatSA regularly publishes the following
table on the CPI:
You have to be able to use the information
on this table to calculate inflation rates on
a:
month-on-month basis
annual average on annual average

 Month-on-month:
To calculate the inflation rate from one
month in the one year to the next year, look
at the following example: What is the
inflation rate from July 2012 to July 2013?

 Annual average on annual average:

To calculate the inflation rate from the annual
average of one year to the annual average of
the next year look at the following example:
What is the inflation rate from the average CPI
of
2012 to the average of 2013?

 With the above information, calculate the

following:
1. The inflation rate according to the CPI of
March 2009 to March 2010
2. The inflation rate according to the average
3. Answer: Yes
annual
to 2011
1. Answer:
5.16%CPI of 2010
2. Answer: 4,99%
and Yes. Both
Ask3.
your
e-tutor
if
Ask
your
e-tutor
if
Do these inflation rates fall within the
fall in the 3-6%
you could not get
you could not get
inflation target margin
of the SARB? inflation target
the correct
the correct
answer.

answer.

range of the
SARB.

9.2 PPI
The production price index places more focus on measuring
the price of producing (cost of production) rather than
consuming, like the CPI does (cost of living).
The PPI includes intermediary goods but excludes services.
Goods like food are more important in the CPI than in the PPI.
PPI records the first goods at the first significant commercial
transaction, for example imports are measured when they
enter the country, not when they are sold (like in the CPI).
Due to the differentiation made between imports and other
goods, the effect of the rand depreciation and appreciation
can also be seen on the PPI.
PPI can be seen as a warning sign as what will soon happen
to the CPI.

9.2 Implicit GDP deflator

Recall from learning unit 5; nominal GDP is
calculated in current prices while real GDP is
calculated in constant prices (in order to
express the growth of GDP without inflation).
Therefore, if you have the GDP both in
constant and current prices, you can calculate
the effect of inflation.
This is done in two steps, whichwill be
explained by aid of an example:
Calculate the inflation rate of 2005 by using the
GDP deflator.

First step: get the GDP deflator for

2012 and 2013
In order to get the
value of the GDP
deflator of each year,
use the following
equation and table:

GDP at
current
prices

GDP at
constant
prices

2012

3 262 545

2 899 248

2013

3 534 327

2 963 389

2014

3 796 460

3 008 576

Year

Now calculate the GDP

deflator for 2014.
Did you get 126,2? If not,
consult with your e-tutor.

Second step: calculate the percentage

growth in the GDP deflator
GDP deflator 2012 = 112,5
GDP deflator 2013 = 119,3
Answer: 5,78%
ask your etutor if you
could not get
the correct
answer.

Year
2013

NOW, calculate the inflation2014

rate
for 2014 with the following info:

GDP at
current
prices

GDP at
constant
prices

3 534 327

2 963 389

3 796 460

3 008 576

Read section
20.3 in
textbook
pp 384-388

9.3 Effects of inflation

Distribution effects:
Inflation causes winners and losers in the economy.
If you borrow R10 000 from me and promise to pay
me back in one year, with 5% interest rate, you will
pay R10 500 back. But if the inflation rate is 10%,
then the R10 500 will only be worth R9 450, as it
lost 10% of its value due to inflation. Therefore, I
lost money due to inflation and you won that
money.
Do you understand how the youth and the
government win from inflation? Ask your e-tutor if
you do not understand.

9.3 Effects of inflation

Economic effects:
People try to avoid inflation rates; in the process they
reorganise their wealth, which has little advantage for
the economy. Inflation also discourages savings,
which is important for an economy. Inflation can also
distort the balance of payments, if our inflation rates
are a lot higher than other countries.
Social and political effects:
Society gets upset if prices keeps rising. People blame
each other and strike. This is bad for the economy.

Only read
Demand-pull
and cost-push
inflation in
section 20.4 in
textbook
pp 388-389

9.4 Causes of inflation

It is difficult to pinpoint the causes of inflation.

If you ask anybody why the prices increases,
they will blame someone else, for example the
government, the large companies, the work
force, the foreign sector, etc.
And it is difficult to find the cause of inflation.
There are three causes of inflation that we are
going to look into further:
Demand-pull inflation
Cost-push inflation
Conflict approach to inflation

9.4 Demand-pull inflation

E4 AS
P4
E3

P3
Price level

Remember the AD-AS

framework? The general price
level was on the y-axis. And
inflation is the increase in the
price level.
Thus, if AD increases (either due
to an increase in C, I, G or NX):
There will be an increase in the
price level, which means there
will be inflation.
There will also be an increase in
total production
up until full employment is
reached.
After full employment has been
reached, an increase in AD will
only cause inflation and no/little
increase in production

P2
P1

E2
E1

AD

Y1 Y2

Yf

Total production, income

9.4 Cost-push inflation

AS AS

Price level

Cost-push inflation is due to an

increase in the production cost.
(Look up the five possible causes on
page 389-390.)
Increased production costs shifts the
AS curve to the left.
This causes an increase in the price
level; thus, inflation.
And a decrease in production,
therefore an increase in
unemployment.
The new equilibrium is an example
of stagflation.
Income policy could be used to
manage these types of changes in
the economy.
In reality, it is difficult to distinguish
between demand-pull and cost-push
inflation.

P2
P1

E2
E1

AD

Y2 Y1
Total production, income

9.4 Conflict approach to

inflation
Different groups in the economy (such as
labour, management, entrepreneurs etc)
claim increases (e.g. increases in wages,
in salaries, in profit etc).
This arises because of lack of consensus
on the division of national income.
The amount that has been produced in the
economy has to be divided among all
these groups.

9.4 Conflict approach to inflation

How much people

want

How much
people want to
produce

>

Claims on GDP @ current

prices exceed value of
GDP at current prices

9.4 Conflict approach to inflation

Interest groups in society have a certain
degree of economic and/or political
power, which then governs its claims on
national income.
There is no economic and/or political
mechanism that guarantees a balance
between the claims on national income
and the contributions to national income.

9.4 Conflict approach to inflation

Since there is no reason why contributions
should increase in response to before fact or ex
ante imbalance, two possible equilibrating ex
post factors arise:
an increase in net imports as a supplementary
mechanism to domestic contributions
an increase in general prices i.e. inflation

An increase in imports will have to be financed

by an inflow of foreign capital and/or decrease in
net foreign reserves not a sustainable option
Thus ONLY one equilibrating factor will remain
i.e. increase in general price levels.

9.4 Conflict approach to inflation

Value of claims decreases due
to higher prices, e.g. value of
wage decreases when prices
increase

How much
people
Value of
want claims
The nominal
value received
by participants
has increased
but not the real
value.

=
>

How
much
people
want to
produce

To make value of claims equal

to production

9.4 Conflict approach to inflation

Note that
production has
Value of production increases
not really
due to higher prices
increased it is
just the value
that has been
inflated due to
How
higher prices.

How much people

want
The conflict
approach tells us
that the only way to
solve inflation is to
limit the claims of
the different
participants in the
economy.

=
>

much
people
want to
produce

To make value of claims equal

to production

Are you able to

define inflation?
describe what the CPI, PPI and implicit GDP deflator are?
differentiate between the CPI and PPI?
define demand-pull inflation?
define cost-push inflation?
differentiate between nominal and real values?
explain why policy-makers regards inflation as a problem?
distinguish between the main types of costs of inflation?
describe what measures can be used to get rid of demand-pull
inflation or cost-push inflation?
explain with and without a diagram the difference between
demand-pull and cost-push inflation?
explain the impact of measures taken to get rid of demand-pull
and cost-push inflation?
calculate the inflation rate?
explain the conflict approach to inflation?

Good job!
Only two more
learning units
to go!

That is the end of learning

unit 9.
A quiz on this work will be
available soon; make sure you
do it and discuss it
with your e-tutor!