1.5.1. Causes of inflation
1.5.1.a. The cost push-inflation (On the supply
side)
Inflation is primarily caused by an increase in the money
supply that outpaces economic growth. Ever since industrialized nations moved
away from the gold standard during the past century, the value of money is
determined by the amount of currency that is in circulation and the public's
perception of the value of that money. When the Central Bank decides to put
more money into circulation at a rate higher than the economy's growth rate,
the value of money can fall because of the changing public perception of the
value of the underlying currency. As a result, this devaluation will force
prices to rise due to the fact that each unit of currency is now worth less.
The same logic works for currency; the less currency there is in the money
supply, the more valuable that currency will be. When a government decides to
print new currency, they essentially water down the value of the money already
in circulation. A more macroeconomic way of looking at the negative effects of
an increased money supply is that there will be more Rwandan currency chasing
the same amount of goods in economy which will inevitably lead to increased
demand and therefore higher prices.
Cost-Push Effect
Another factor in driving up prices of consumer goods and
services is explained by an economic theory known as the `cost-push
effect'. Essentially, this theory states that when companies are
faced with increased input costs like raw goods and materials or wages, they
will preserve their profitability by passing this increased cost of production
onto the consumer in the form of higher prices. Inflation can be categorized
into many but the most current ones are: Demand Pull Inflation this is a kind
of inflation that occurs on demand side where the demand for goods and services
exceed the supply.
Cost Push Inflation: this is a kind of inflation that occurs
on the supply side where price increases due to an increase in price of other
products.
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Calculation of Inflation
For example, CPI on Jan 1, 2013 is 125 and that on Jan 1, 2014
is 133.75 then inflation for the year 2014 would be:
Or:
Therefore:
The National Debt
In economics, the reason for this is that if there is a
country's debt increases, the government has two options: it can either raise
taxes or print more money to pay off the debt. A rise in taxes will cause
businesses to react by raising their prices to offset the increased corporate
tax rate. Alternatively, should the government choose the latter option,
printing more money will lead directly to an increase in the money supply,
which will in turn lead to the devaluation of the currency and increased
prices.
1.5.1. b Demand-Pull Inflation (On the demand side)
The demand-pull effect states that as wages increase within an
economic system (often the case in a growing economy with low unemployment),
people will have more money to spend on consumer goods. This increase in
liquidity and demand for consumer goods results in an increase in demand for
products. As a result of the increased demand, companies will raise prices to
the level the consumer will bear in order to balance supply and demand. An
example would be a huge increase in consumer demand for a product or service
that the public determines to be cheap. For instance, when hourly wages
increase, many people may determine to undertake home improvement projects.
This increased demand for home improvement goods and services will result in
price increases by house-painters, electricians, and other general contractors
in order to offset the increased demand. This will in turn drive up prices
across the board.
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