Question

1. What is inflation. Give an example.

2. What is hyperinflation. Give an example.

3. Explain the causes of hyperinflation?

4. Explain the costs of hyperinflation.

5. Why sometimes governments are unable to borrow by issuing debt?

Answer 1

Inflation
Inflation is the general increase in the price of goods and services over a period of time. Also, with this, it reduces the purchasing power per unit of currency.

Example - In 1913, the price per gallon of milk was 36 cents and whereas 100 years in 2013, the cost increased to $3.53.

Hyperinflation
Hyperinflation is when the prices of goods and services increase at an uncontrollable rate over a period of time. Generally, if the prices increase at 50% per month is considered to be hyperinflation

Example - In 2013, inflation in Venezuela was 43% p.a. which increased to 65,000% p.a. by 2018.

Causes of Hyperinflation

1) Printing of money by govt - If the govt starts printing a lot of money to pay for its spending, that will lead to higher than normal money supply in the market and with higher money supply, the prices increase.

2) Demand Pull - With the inflation out of control, the consumers will expect the prices to increase, so they will purchase more goods and services as of today and this will lead to higher demand & thus increase the prices

3) Large Govt Debt - If the govt's debt is higher than the GDP of the economy, then the govt will start printing money to honour the debt and hence, that will lead to increase in money supply.

Costs of Hyperinflation

1) Lack of Economic Growth
With hyperinflation, people will need a lot of money to buy a few little goods. With that, the producers will receive higher selling price (purely due to inflation) but the costs will remain same (costs will increase at the same rate as selling price) and the demand will plunge. Because of this, the producers will not invest more into the country to produce more goods.

2) Value of savings diminishes
With hyperinflation, a lot of money will buy few things only. And people will not save but spend the money right away because the prices of the goods increase at exponential rate. At the same time the marginal return earned from savings kept in the bank will be lesser than the inflation rate.