Sample Essay on Factors that Influence Inflation Rate

Sample Essay on Factors that Influence Inflation Rate

There are many factors that influence the inflation rate. However, these factors are all related to demand and supply. If the amount of money supply in a country is high while its demand is low, prices of commodities rise. In turn, this causes a decline in the value of the money supply in the country.

This is due to the fact that the goodness of money is determined by what one can purchase with it. If the prices of commodities are higher in a year than the previous year, then this implies that the country made money that is less valuable than a year than the previous year.

Cost is one of the factors that influence the inflation rate. Cost-push inflation occurs when the price of commodities generally rises due to the costs that are associated with these commodities. For instance, if the companies that produce a certain commodity are required to pay a 5% tax, the companies will increase the price of the commodity by a similar percentage in order to cater for the cost of the added taxation. This implies that individuals purchasing the commodity will have to pay the additional cost.

Demand-pull also influences the inflation rate. This is common in growing economies. In this case, the demand for commodities increases as the income increases. This results in decreasing supply causing the price of commodities to go up. Demand-pull inflation can be caused by various factors but all of them are linked to the ability of people to generate more money.

The role of the central bank also influences the inflation rate in a country. This is because the central bank sets interest rates for lending money to the other banks. If the rates are high, people will not be willing to borrow money for financing new enterprises and other activities. This reduces demand and may curtail inflation in some cases.

When the central bank does the opposite, people will borrow more, have money and this will increase demand. In most cases, the inflation rate increases when the lending rates by the central bank are cheaper than they should.

Price expectations by the people can also influence the inflation rate in a country. When consumers expect the prices to keep increasing, they are not likely to accept a pay rise that is not more than the expected rate of inflation. This is because they want to have protection for the purchasing power afforded by their income.

Wage price spiral danger looms when workers intend to negotiate for higher wages. This calls for the introduction of deflationary policies including direct taxation and an increase in interest rates.

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