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INTRODUCTION

Inflation is defined as a sustained increase in the general level of prices for goods and
services. It is measured as an annual percentage increase. As inflation rises, every peso a
person owns buys a smaller percentage of a good or service. One consequence of inflation in
the economy is the decline of the purchasing power of currency.
Another important subject matter is the principle of the domino effect. It is defined as the
outcome of an event under which every associated or connected entity is affected to a more or
less the same degree. The principle of the domino effect is also existent in the economy. One
example is the given situation for this study; a passive consumer may ignore a mere peso
increase in the price of goods, but the far-reaching implications of this is aggravated by the fact
that even a small increase in the price of the basic commodity (rice, meat products, sugar, flour
and etc.) or a fuel for an instance, may have a domino effect on other goods in a monitored
basket.
This study is done for the purpose of scrutinizing the factors that could lead to a domino
effect of price increase of basic commodities to every individual and the whole economy. Also, a
few economic principles or concepts related to the groups given situation are discussed as well.

OBJECTIVES
The main objective of this analysis is to distinguish every factor that could lead to a
domino effect of inflation of basic commodities and other goods and services. Furthermore, this
study also points out the following in details:
Recognition of as many potential inflationary triggers as possible
Spread awareness of how deteriorating inflation is to the economy and recognize the kind of
damage it does
For the readers to distinguish those people who are hurt by inflation and those who are not

DEFINITION OF TERMS
Inflation - a sustained increase in the general price level of goods and services in an economy
over a period of time. When the price level rises, each unit of currency buys fewer goods and
services.
Purchasing power - the value of a currency expressed in terms of the amount of goods or
services that one unit of money can buy. The purchasing power of currency decreases as price
increases.
Inflation rate - the percentage increase in the price of goods and services, usually annually. It is
also the percentage rate of change of a price index over time.
Disinflation - a decrease in the rate of inflation; a slowdown in the rate of increase of the
general price level of goods and services in a nation's gross domestic product over time.

Disinflation occurs when the increase in the consumer price level slows down from the
previous period when the prices were rising.
Hyperinflation - a situation where the price increases are so out of control that the concept of
inflation is meaningless. It is simply an extremely rapid or out of control inflation.
Monetary inflation - is a sustained increase in the money supply of a country (or currency
area). Depending on many factors, especially public expectations, the fundamental state and
development of the economy, and the transmission mechanism, it is likely to result in price
inflation, which is usually just called "inflation", which is a rise in the general level of prices of
goods and services.

ISSUES
Inflation has remained high, largely reflecting sharp increases in the prices of
globally traded commodities.
There is almost complete unanimity among economists and various commentators that inflation
consists in general increases in the prices of goods and services. From this it is established that
anything that contributes to price increases sets inflation in motion. A decrease in
unemployment or an increase in economic activity is seen as a potential inflationary trigger.
Some other triggers, such as increases in commodity prices or workers wages, are also
regarded as potential threats.
If inflation is just a general increase in prices, as popular thinking has it, then why
is it regarded as bad news? What kind of damage does it do?
Mainstream economists maintain that inflation causes speculative buying, which generates
waste. Inflation, it is maintained, also erodes the real incomes of pensioners and low-income
earners and causes a misallocation of resources. Inflation, it is argued, also undermines real
economic growth.
Why should a general increase in prices hurt some groups of people and not
others? And how does inflation lead to the misallocation of resources? Why should a
general increase in prices weaken real economic growth? If inflation is triggered by other
factors, then surely it is just a symptom and can't cause anything as such.
We know that a price of a good is the amount of money paid for the good. From this we can
infer that for any given amount of goods, a general increase in prices can only take place in
response to the increase or inflation of the money supply.
Can Increases in Commodity Prices Cause Inflation?
We have seen that, it is increases in commodity prices such as oil that are behind the recent
strong increases in the prices of goods and services.
If the price of oil goes up, and if people continue to use the same amount of oil as before,
people will be forced to allocate more money to oil. If people's money stock remains unchanged,
less money is available for other goods and services, all other things being equal. This of course
implies that the average price of other goods and services must come down. Remember: a price

is the sum of money paid for a unit of a good. Note that the overall money spent on goods
doesn't change; only the composition of spending has altered, with more on oil and less on
other goods. Hence the average price of goods or money per unit of good remains unchanged.
Likewise, the rate of increase in the prices of goods and services in general is going to be
constrained by the rate of growth of money supply, all other things being equal, and not by the
rate of growth of the price of oil.
It is not possible for increases in the price of oil to set in motion a general increase in the prices
of goods and services without corresponding support from the money supply.
Can Inflation Expectations Trigger a General Price Rise?
We have seen that as a rule a general increase in the prices of goods can emerge as a result of
the increase in the amount of money paid for goods, all other things being equal. The key then
for general increases in prices, which is labeled by popular thinking as inflation, is increases in
the money supply, e.g., the supply of Philippine Peso. But what about the situation when
increases in commodity prices ignite inflation expectations, which in turn strengthens the rate of
inflation? Surely then inflation expectations must be also an important driving factor of inflation?
Once people start to anticipate higher inflation in the future, they increase their demand for
goods at present thus bidding the prices of goods higher. Also, according to popular thinking,
workers expectations for higher inflation prompt them to demand higher wages. Increases in
wages in turn lift the cost of producing goods and services and force businesses to pass these
increases on to consumers by raising prices.
It is true that businesses set prices and it is also true that businessmen, while setting prices,
take into account various costs of production. However, businesses are ultimately at the mercy
of the consumer, who is the final arbiter.
The consumer determines whether the price set is "right," so to speak. Now, if the money stock
did not increase, then consumers won't have more money to support the general increase in
prices of goods and services.
Also, because of expectations for higher prices in the future, consumers will not be able to
increase their demand for goods at present and bid the prices of goods higher without having
more money. Consequently, the amount of money spent per unit of goods will stay unchanged.
So irrespective what people's expectations are, if the money supply hasn't increased, then
people's monetary expenditure on goods cannot increase either. This means that no general
strengthening in price increases can take place without an increase in the pace of monetary
pumping.
Imagine that somehow the Fed did manage to convince people that central bank policies are
aimed at stopping inflation and maintaining price stability, yet at the same time the central bank
also increased the rate of growth of money supply. Even if inflationary expectations were stable,
that destructive process would be set in motion, regardless of these expectations, because of
the increase in the rate of growth of money. People's expectations and perceptions cannot offset
this destructive process. It is not possible to alter the facts of reality by means of expectations.
The damage that was done cannot be undone by means of expectations and perceptions.
CONCEPTS AND PRINCIPLES OF INFLATION

When the prices of basic commodities are low, there is a higher standard of living and
vice versa. While it is true that unemployment poses a greater problem than inflation, for
unemployment represents sheer waste, in inflation there are winners and losers, not taking
away the fact that so much resentment is also tagged to it. When prices rise, producers are
given the incentive to produce more, but buyers suffer, and they will need more money to cope
with higher prices. Even though there is inflation, it does not necessary mean that all
commodities have higher prices; in some instances, the prices of some commodities fall even if
there is inflation. What is difficult about inflation is that prices rise unevenly. Some commodities
rise, others decline while others do not at all.
Inflation is a sustained increase in the average price level, or it is the rate of change of
the Consumer Price Index (CPI). CPI relates the prices urban consumers paid for a fixed basket
of approximately 40 goods to the prices paid for this same basket during a base year. As such
the CPI is a fixed weight index where it is assumed that individuals do not change spending
patterns in response to price changes.
Effects of inflation are huge. And it doesnt just affect areas like our salaries and the cost
of purchasing a new home. Inflation hits us from every angle. Food prices go up, transportation
prices increase, gas prices rise, and the cost of various other goods and services skyrocket over
time. All of these factors make it absolutely essential that you account for the huge impacts that
inflation can have on your long-term savings and ability to fund your golden years of retirement.
Causes of inflation
1. Demand-pull inflation. Too much spending chasing too few goods is an apt description of
demand-pull inflation. It occurs when the level of spending in the economy exceeds the amount
firms are capable of producing. Excess demand pulls the general price level.
2. Cost push and supply shock inflation. Both refer to similar situations, when factors on the
supply side of the economy push up cost of production and force firms to raise prices. Cost
push inflation is the term frequently used when labor unions demand for higher wages. Supply
shock inflation is more of recent theory. It occurs when a vital resource becomes scarce,
causing its price to rise and raising the costs of production for firms. For example, the current
increase in the prices of oil products causes the prices of basic commodities to increase also.
Losers in Inflation
1. Holders of Securities. People who have investment in both bonds and stocks lose during
the time of inflation. The value of their money invested in securities depreciates in terms of
purchasing power.
2. Pension Holders. The elderly are also losers in inflation, because they are receiving fixed
monthly pensions: any increase in inflation will reduce the amount of goods and services it can
purchase.
3. Fixed Income Earners. Laborers and office workers who are getting a fixed amount of
money monthly cannot keep up with the accelerating inflation. The real income of these workers
diminishes and they feel the effect of inflation.

Winners in Inflation

1. Windfall to Fixed Asset Owners. Land owners gain during inflation as the value of land and
other fixed assets appreciate.
2. Producers. The income of producers increases when inflation takes place: as the price of
commodities increase, it results to higher returns for business firms.
Inflation is an economic phenomenon that has an increasing change in the price of goods and
services. A closely linked phenomenon to inflation is deflation, sometimes called negative
inflation. Price inflation decreases people's ability to pay for goods. The concept at a basic level
says if an employee's wages remain steady, but the cost of goods increases, then the employee
can afford fewer goods. As wage inflation occurs, people will be able to buy more products.
Like it or not, inflation is real. Ignoring the effects that inflation can and will have on your longterm savings is probably one of the biggest mistakes that many investors make. Understanding
the detrimental causes and effects of inflation is the first step to making long-term decisions to
mitigate the risks. But the next step is taking action.

Analysis or discussion
EFFECTS OF INFLATION TO THE INDIVIDUAL
When prices rise for energy, food, commodities and other goods and services, the entire
economy is affected. Rising prices, known as inflation, impact the cost of living, the cost of doing
business, borrowing money, mortgages, corporate and government bond yields, and every other
facet of the economy.
Persistently high inflation can have damaging economic and social consequences:
Income redistribution - Inflation has a regressive effect on lower-income families and older
people in society. It happens when prices for food and domestic utilities increase.
Falling real incomes - Millions of people are facing a cut in their wages or at best a pay freeze,
inflation will affect their real incomes.
Negative real interest rates - If interest rates on savings accounts are lower than inflation,
people who rely on interest from their savings will be poorer.
Cost of borrowing - High inflation may also lead to higher interest rates for businesses and
people needing loans and mortgages as financial markets protect themselves against rising
prices and increase the cost of borrowing on short and longer-term debt. There is also pressure
on the government to increase the value of the state pension and unemployment benefits and
other welfare payments as the cost of living climbs higher.
Risk of wage inflation - High inflation can lead to an increase in pay claims as people look to
protect their real incomes. This can lead to a rise in unit labor costs and lower profits for
businesses.
Business competitiveness - If one country has a much higher rate of inflation than others for a
considerable period of time, this will make its exports less price competitive in world markets.
Eventually, this may show through in reduced export orders, lower profits and fewer jobs and

also in a worsening of a countrys trade balance. A fall in exports can trigger negative multiplier
and accelerator effects on national income and employment.
Business uncertainty - High and volatile inflation is not good for business confidence partly
because they cannot be sure of what their costs and prices are likely to be. This uncertainty
might lead to a lower level of capital investment spending.

EFFECTS OF INFLATION TO THE ECONOMY


Inflation affects an economy in various positive and negative ways. Negative effects of inflation
include an increase in the opportunity cost of holding money, uncertainty over future inflation
which may discourage investment and savings, and if inflation were rapid enough, shortages of
goods as consumers begin hoarding out of concern that prices will increase in the future.
Positive effects include reducing the real burden of public and private debt, keeping nominal
interest rates above zero so that central banks can adjust interest rates to stabilize the
economy, and reducing unemployment due to nominal wage rigidity.
Economists generally believe that high rates of inflation and hyperinflation are caused by an
excessive growth of the money supply. However, money supply growth does not necessarily
cause inflation. Some economists maintain that under the conditions of aliquidity trap, large
monetary injections are like "pushing on a string". Views on which factors determine low to
moderate rates of inflation are more varied. Low or moderate inflation may be attributed to
fluctuations in real demand for goods and services, or changes in available supplies such as
during scarcities.[9] However, the consensus view is that a long sustained period of inflation is
caused by money supply growing faster than the rate of economic growth.
General
An increase in the general level of prices implies a decrease in the purchasing power of the
currency. That is, when the general level of prices rises, each monetary unit buys fewer goods
and services. The effect of inflation is not distributed evenly in the economy, and as a
consequence there are hidden costs to some and benefits to others from this decrease in the
purchasing power of money. For example, with inflation, those segments in society which own
physical assets, such as property, stock etc., benefit from the price/value of their holdings going
up, when those who seek to acquire them will need to pay more for them. Their ability to do so
will depend on the degree to which their income is fixed. For example, increases in payments to
workers and pensioners often lag behind inflation, and for some people income is fixed. Also,
individuals or institutions with cash assets will experience a decline in the purchasing power of
the cash. Increases in the price level (inflation) erode the real value of money (the functional
currency) and other items with an underlying monetary nature.
Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real"
interest rate as the inflation rate rises. The real interest on a loan is the nominal rate minus the
inflation rate.

Negative

High or unpredictable inflation rates are regarded as harmful to an overall economy. They add
inefficiencies in the market, and make it difficult for companies to budget or plan long-term.
Inflation can act as a drag on productivity as companies are forced to shift resources away from
products and services in order to focus on profit and losses from currency inflation. Uncertainty
about the future purchasing power of money discourages investment and saving. Inflation can
also impose hidden tax increases. For instance, inflated earnings push taxpayers into higher
income tax rates unless the tax brackets are indexed to inflation.
With high inflation, purchasing power is redistributed from those on fixed nominal incomes, such
as some pensioners whose pensions are not indexed to the price level, towards those with
variable incomes whose earnings may better keep pace with the inflation. This redistribution of
purchasing power will also occur between international trading partners. Where fixed exchange
rates are imposed, higher inflation in one economy than another will cause the first economy's
exports to become more expensive and affect the balance of trade. There can also be negative
impacts to trade from an increased instability in currency exchange prices caused by
unpredictable inflation.
Cost-push inflation
High inflation can prompt employees to demand rapid wage increases, to keep up with
consumer prices. In the cost-push theory of inflation, rising wages in turn can help fuel inflation.
In the case of collective bargaining, wage growth will be set as a function of inflationary
expectations, which will be higher when inflation is high. This can cause awage spiral. In a
sense, inflation begets further inflationary expectations, which beget further inflation.
Hoarding
People buy durable and/or non-perishable commodities and other goods as stores of wealth, to
avoid the losses expected from the declining purchasing power of money, creating shortages of
the hoarded goods.
Social unrest and revolts
Inflation can lead to massive demonstrations and revolutions. For example, inflation and in
particular food inflation is considered as one of the main reasons that caused the 20102011
Tunisian revolution, and the 2011 Egyptian revolution.
Hyperinflation
If inflation becomes too high, it can cause people to severely curtail their use of the currency,
leading to acceleration in the inflation rate. High and accelerating inflation grossly interferes with
the normal workings of the economy, hurting its ability to supply goods. Hyperinflation can lead
to the abandonment of the use of the country's currency (for example as in North Korea) leading
to the adoption of an external currency (dollarization).
Allocative efficiency
A change in the supply or demand for a good will normally cause its relative price to change,
signaling the buyers and sellers that they should re-allocate resources in response to the new
market conditions. But when prices are constantly changing due to inflation, price changes due
to genuine relative price signals are difficult to distinguish from price changes due to general
inflation, so agents are slow to respond to them. The result is a loss of allocative efficiency.

Shoe leather cost


High inflation increases the opportunity cost of holding cash balances and can induce people to
hold a greater portion of their assets in interest paying accounts. However, since cash is still
needed in order to carry out transactions this means that more "trips to the bank" are necessary
in order to make withdrawals, proverbially wearing out the "shoe leather" with each trip.
Menu costs
With high inflation, firms must change their prices often in order to keep up with economy-wide
changes. But often changing prices is itself a costly activity whether explicitly, as with the need
to print new menus, or implicitly, as with the extra time and effort needed to change prices
constantly.
Business cycles
According to the Austrian Business Cycle Theory, inflation sets off the business cycle. Austrian
economists hold this to be the most damaging effect of inflation. Artificially low interest rates and
the associated increase in the money supply are said to lead to reckless, speculative borrowing,
resulting in clusters of malinvestments, which eventually have to be liquidated as they become
unsustainable. Economists such as Gottfried von Haberler, Milton Friedman, Gordon Tullock,
Bryan Caplan, and Paul Krugman have argued that the theory is incorrect.

Positive
Labor-market adjustments
Nominal wages are slow to adjust downwards. This can lead to prolonged disequilibrium and
high unemployment in the labor market. Since inflation allows real wages to fall even if nominal
wages are kept constant, moderate inflation enables labor markets to reach equilibrium faster.
Room to maneuver
The primary tools for controlling the money supply are the ability to set the discount rate, the
rate at which banks can borrow from the central bank, and open market operations, which are
the central bank's interventions into the bonds market with the aim of affecting the nominal
interest rate. If an economy finds itself in a recession with already low, or even zero, nominal
interest rates, then the bank cannot cut these rates further (since negative nominal interest rates
are impossible in order to stimulate the economy this situation is known as a liquidity trap.
MundellTobin effect
The Nobel laureate Robert Mundell noted that moderate inflation would induce savers to
substitute lending for some money holding as a means to finance future spending. That
substitution would cause market clearing real interest rates to fall. The lower real rate of interest
would induce more borrowing to finance investment. In a similar vein, Nobel laureate James
Tobin noted that such inflation would cause businesses to substitute investment in physical
capital (plant, equipment, and inventories) for money balances in their asset portfolios. That
substitution would mean choosing the making of investments with lower rates of real return.
(The rates of return are lower because the investments with higher rates of return were already

being made before.) The two related effects are known as the MundellTobin effect. Unless the
economy is already overinvesting according to models of economic growth theory, that extra
investment resulting from the effect would be seen as positive.

Instability with deflation


Economist S.C. Tsiang noted that once substantial deflation is expected, two important effects
will appear; both a result of money holding substituting for lending as a vehicle for saving. The
first was that continually falling prices and the resulting incentive to hoard money will cause
instability resulting from the likely increasing fear, while money hoards grow in value, that the
value of those hoards are at risk, as people realize that a movement to trade those money
hoards for real goods and assets will quickly drive those prices up. Any movement to spend
those hoards "once started would become a tremendous avalanche, which could rampage for a
long time before it would spend itself." Thus, a regime of long-term deflation is likely to be
interrupted by periodic spikes of rapid inflation and consequent real economic disruptions.
Moderate and stable inflation would avoid such a seesawing of price movements.

Financial market inefficiency with deflation


The second effect noted by Tsiang is that when savers have substituted money holding for
lending on financial markets, the role of those markets in channeling savings into investment is
undermined. With nominal interest rates driven to zero, or near zero, from the competition with a
high return money asset, there would be no price mechanism in whatever is left of those
markets. With financial markets effectively euthanized, the remaining goods and physical asset
prices would move in perverse directions. Moderate inflation, once its expectation is
incorporated into nominal interest rates, would give those interest rates room to go both up and
down in response to shifting investment opportunities, or savers' preferences, and thus allow
financial markets to function in a more normal fashion.