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Impact of Inflation on Poverty

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  1.   Impact of inflation on poverty    If inflation occurs (prices on all goods throughout an economy go up) but wages remain the same, extra financial stress is placed on people to buy the same products they were able to buy before. For example, say you make $6 US dollars an hour at your job, perhaps this is minimum wage where you live. If you work for five hours and make $30 dollars, let's say hypothetically this $30 dollars will buy you exactly a full tank of gas if gas was at about $2.50/gal. But if the price of gas inflates to $4+, you would no longer be able to fill the same tank of gas you could fill before with five hours of wages. Also, with the inflation of gasoline prices, ALL product prices are inflating becasue it takes gasoline to transport nearly all goods, whether by plane, train, or boat. So not only does gas cost more, food is costing more too, etc. This is how inflation takes a toll on people who are already struggling to live paycheck-to-paycheck, and may plunge these people who were doing fine before into poverty, since they cannot afford the goods they once were able to.    The people that benefit most from inflation are those that have large debts, especially those at a fixed interest rate. As prices rise, so must wages, at least for employment where there are alternatives for the worker to go elsewhere. People who have large debts are usually not the same folks as we consider poor , as poor people do not normally qualify for large loans. Wealthy people often have investment options to protect themselves from some of the effects of inflation. When inflationary pressures appear, the astute investor shifts out of those investments likely to suffer, and go to instruments that will keep pace with inflation, thus protecting themselves from some of the damage inflation might otherwise inflict on their portfolio. So, since pay increases normally lag behind inflation, and often do not catch up to price increases, the poor, who normally spend 100% of their income on those things most affected by inflation, tend to be hurt by inflation to a larger degree than large debtors, or investors who can shift assetts to gold or other commodities that typically keep pace with inflation.    inflation is when prices go up. this can be due from the value of a dollar. if the value of the dollar goes down then the price of products will go up. this is because ti will take more dollars to make the product. since it will cost more money to make the product, the prices will go up. since prices are going up because of the low dollar value, it costs more to live. Ex. someone makes a standard $40,000 annual salary. it costs them $37,000 to pay all the bills (taxes, food ect.). if inflation occurs, then it might cost $41,000 to pay the bills. since the prices  went up that means the bills are. that means people have less to spend. because of this people are running low on money, that leads to poverty. 2.   Impact of inflation in employment, unemployment, underemployment    Inflation in employment A problem arises when monetary policy is used to reduce inflation. There is a short term trade-off between unemployment and inflation. In 1958, economist A. W. Philips published an article showing that when inflation is high, unemployment is low, and vice versa. This relationship, when graphed, came to be known as the Phillips curve . When monetary policy is used to reduce inflation, either by contracting the money supply or by raising interest rates, this reduces aggregate demand, while aggregate supply remains the same. When aggregate demand decreases, prices decrease, but unemployment rises.    Meaning of unemployment What is Unemployment?   - In economics one who is willing to work at a prevailing wage rate but is unable to find a paying job is considered to be unemployed. What is Unemployment rate?   - The unemployment rate is the no. of unemployed workers divided by the total civilian labor force. According to the ILO, a person is said to be unemployed   if the person is: 1. Not working 2. Currently available for work 3. Seeking work 36   classify unemployment into four different categories Frictional unemployment   Seasonal unemployment   Structural unemployment   Cyclical unemployment   Each arises from a different cause   and has different consequences 37   normal entry and exit from the labor market, voluntary job changes, or lay offs or firings. Also called search unemployment. Mainly in industrial countries because of the frequent change in technology or because of dynamic economy. By definition, it is short-term, it causes little hardship to   those affected by it. By spending time searching rather than jumping at the   first opening that comes their way. People find jobs for which they are better suited and in which they will ultimately be more productive. 38   tourist patterns, or other seasonal factors. A common phenomenon is developing   countries and specially in agriculture economies. Mainly occurs in agriculture, construction and   tourism business-a demand driven situation. Also in supply side, teenage unemployment   rises during vacations. 39 Structural Unemployment Joblessness arising from mismatches    between workers’ skills and employers’ requirements Generally a stubborn, long -term problem   Often lasting several years or more because it   can take considerable time to relocate or acquire new skills. 40   largely from microeconomic causes, they cannot be entirely eliminated since they are attributed to changes in specific industries and specific labor markets. Some amount of microeconomic unemployment is a   sign of a dynamic economy. When there is no cyclical unemployment, it is called   natural rate of unemployment. Thus, the natural rate of unemployment is defined as   the rate of unemployment at which the actual rate of inflation equals the expected rate of inflation. It is thus an equilibrium rate of unemployment towards which the economy moves in the long  –  run. 41   output falls, the unemployment rate rises Since it arises from conditions in the overall economy,   cyclical unemployment is a problem for macroeconomic policy It is caused by the business cycle hence called  ‘cyclical’   Macroeconomists say we have reached full employment   when cyclical unemployment is reduced to zero But the overall unemployment rate at full   employment is greater than zero Because there are still positive levels of frictional,   seasonal, and structural unemployment 42 -off (The Phillips Curve) Okun’s law states that 1 extra point of    unemployment costs 2 percent of GDP. The Phillips curve examines the relationship between the   rate of unemployment and rate of money wage changes. The wage push inflation is simply given by: Rate of inflation = Rate of wage growth  –  Rate of    labor productivity growth. This formula shows that if the rate of money wage   change is faster than the rate of labor productivity growth (change), it causes the inflation. In this case, the Phillips curve shows the relationship between the rate of unemployment and the rate of money wage changes or the rate of inflation. Thus, Phillips curve depicts the trade  – off relationship between unemployment rate and inflation rate. 43 -off (The Phillips Curve) The Phillips curve is so named because it was   popularized by a New Zealand economist, A. W. Phillips, when he was working at the London School of Economics in the 1950s. A Phillips curve is a curve showing the relationship   between inflation and unemployment. There are two time-frames for Phillips curves: The short-run Phillips curve   The long-run Phillips curve   44 tion and Unemployment Trade-off (The Phillips Curve) Following Figure Shows Short  –  Run Phillips Curve. Unemployment Rate (%) O 2 3 B C 4 2 PC Inflationrate(%) Expected inflation rate 4% Natural unemployment rate 2% 45 -off (The Phillips Curve) The short-run Phillips curve (SRPC) shows the   relationship between inflation and unemployment at a given expected inflation rate and given natural unemployment rate. With an expected inflation rate of 4 percent a year and a natural unemployment rate of 2 percent, the short run Phillips curve passes through point ‘c’. An unanticipated increase in AD lowers unemployment and increases inflation-a movement up the SRPC. An unanticipated decrease in AD increases unemployment and lowers inflation-a movement down the SRPC. 46 -off (The Phillips Curve) The long-run Phillips curve (LRPC) is a curve that shows   the relationship between inflation and unemployment, when the actual inflation rate equals the expected inflation rate. The LRPC is vertical at the natural unemployment rate. The LRPC tells us that any anticipated inflation rate is possible at the natural unemployment rate. When inflation is anticipated, real GDP remains at potential GDP. Real GDP being at potential GDP is equivalent to unemployment being at the natural ate. 47 -off (The Phillips Curve)Inflationrate Unemployment rate LRPC 6 10 SRPC SRPC1 7 9 a d c 48 -off (The Phillips Curve) The LRPC is a vertical line at the natural   unemployment rate. A fall in inflation expectations shifts the SRPC downward by the amount of the fall in the expected inflation rate. In the figure of the previous slide, when the expected inflation rate falls from 10 percent a year to 7 percent a year, the SRPC shifts downward. The new SRPC intersects the LRPC at the new expected inflation rate-point d. With the srcinal expected inflation rate (10 percent), an inflation rate of 7 percent a year would occur at an unemployment rate of 9 percent-point c. Remember change in the natural rate of    unemployment shifts both SRPC and LRPC. 49 -off (The Phillips Curve) Following Figure Shows Tobin's Phillips Curve. O Uc PS Unemployment Rate % InflationRate% 50   within the limits but as the economy expands and employment grows, the curve becomes even more fragile and vanishes until it becomes vertical at some critically low rate of unemployment. The Phillips curve is kinked  –  shaped, a part like a  normal Phillips curve and the rest vertical, as shown in the previous slide. The unemployment rate at which the Phillips curve   is vertical is called critical unemployment rate. 51 -price spiral  –  price rises can   lead to higher wage demands as workers try to maintain their real standard of living. Higher wages over and above any gains in labour productivity causes an increase in unit labour costs. To maintain their profit margins they increase prices. The process could start all over again and inflation may get out of control. Higher inflation causes an upward spike in inflationary   expectations that are then incorporated into wage bargaining. It can take some time for these expectations to be controlled. Higher inflation expectations can cause an outward shift in the Phillips Curve. 52   value of savings - especially if real interest rates are negative. This means the rate of interest does not fully compensate for the increase in the general price level. In contrast, borrowers see the real value of their debt diminish. Inflation, therefore, favors borrowers at the expense of savers. Consumers and businesses on fixed incomes   will lose out. Many pensioners are on fixed pensions so inflation reduces the real value of their income year on year. The state pension is normally uprated each year in line with average inflation so that the real value of the pension is not reduced. 53 ion Inflation usually leads to higher nominal interest   rates that should have a deflationary effect on GDP. Inflation can also cause a disruption of business   planning  –  uncertainty about the future makes planning difficult and this may have an adverse effect on the level of planned capital investment. Budgeting becomes a problem as firms become   unsure about what will happen to their costs. If inflation is high and volatile, firms may demand a higher nominal rate of return on planned investment projects before they will go ahead with the capital spending. 54   rates that should have a deflationary effect on GDP. Inflation can also cause a disruption of business   planning  –  uncertainty about the future makes planning difficult and this may have an adverse effect on the level of planned capital investment. Budgeting becomes a problem as firms become   unsure about what will happen to their costs. If inflation is high and volatile, firms may demand a higher nominal rate of return on planned investment projects before they will go ahead with the capital spending. 55 -push inflation usually leads to a slower   growth of company profits which can then feed through into business investment decisions. Inflation distorts the operation of the price   mechanism and can result in an inefficient allocation of resources. When inflation is volatile, consumers and firms are unlikely to have sufficient information on relative price levels to make informed choices about which products to supply and purchase. 56   the textbooks: Shoe leather costs - when prices are unstable   there will be an increase in search times to discover  more about  prices. Inflation increases the opportunity cost of holding money, so people make more visits to their banks and building societies (wearing out their shoe leather!). Menu costs -extra costs to firms of changing price   information. This can be important for companies who rely on bulky catalogues to send price information to customers. (Note there are also significant menu costs associated with any future transition to the European Single Currency) 57   Anticipated and unanticipated inflation When inflation is volatile from year to year, it  becomes   difficult for individuals and businesses to correctly predict the rate of price inflation that will happen in the near future. When people are able to make accurate  predictions of inflation, they can anticipate what is likely to happen and take steps to  protect themselves. For example, people can bid for increases in money wages so as to maintain their real wages. Savings can be shifted into accounts offering a higher rate of
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