Causes and costs of inflation Essay Example | Topics and Well Written Essays - 1250 words

Causes and be of puffiness - Essay ExampleInflation is defined as an subjoin in the overall train of prices in the economy (Mankiw & Taylor, 2006, p. 817). The rate of pompousness which is the percentage change in the overall train of prices, varies greatly from time to time depending on the condition of the economy and the stage of development of a country. Inflation is broadly speaking measured by calculating the cost of a basket of goods and services bought by an average consumer. This is beat is represented in the form of an index known as the Consumer Price Index (CPI).The rate of fanfare is a cause of concern for policy makers, economists and the public alike. While most laypeople consider the existence of inflation to be undesirable, (because an increase in price levels without a corresponding increase in wages signifies a fall in purchasing power) economist tend to discount the much overplayed costs of inflation. To arrive at a conclusive opinion about the significanc e of the costs of inflation, it is first necessary to understand what causes inflationThe main reason behind cases of high or persistent inflation is the growth in the quantity of gold available in the economy. Monetarists believe that changes in the quantity of money are a get off cause of inflation.The quantity of money available in an economy is known as the money grant and is usually under the control of the government. The money supply in an economy is usually measured by the availability of currency (notes and coins), checkable deposits (demand deposits) as well as saving deposits, plus wholesale currency deposits, and in the broadest sense foreign currency deposits may also be included. Different measures of money are employ according to need but the most common is M2 (Cash in circulation plus demand deposits). (Sloman, 1999, p. 560)The quantity theory of money states that people hold money because they wish to engage in transactions to buy goods and services. The great er the need for transactions the greater will be the amount of money held. The amount of money held is explicit through the following equation, where M=quantity of money, V= velocity of money-the rate at which money circulates, P= average price of a transaction and T= total number of transactions over a period of time.M V = P TIt is more useful and practical to substitute T with Y, which is the level of Output of an economy. The level of output will determine the number of transaction over a period of time and olibanum the equation changes to M V = P YThis equates the quantity of money available to the value of goods and services of an economy (GDP).The velocity of money is held to be constant to make the mannequin simpler. If one variable on the left side of the equation increases then there should be a corresponding increase in one of the variables on the right side. If velocity is taken to be constant, and level of output of an economy is taken to be a function of the factors of production, then any changes in M will result in corresponding change in the price level P. Thus if an increase in money supply causes the nominal GDP to increase and the there is no increase in the output of goods and services then it is an obvious conclusion that the price levels have increased. The quantity theory thus implies that the price level is proportional to the money supply (Mankiw, 2003, pp.