Assume that firms in South Africa experience an increase in the price of inputs and other...

Assume that firms in South Africa experience an increase in the price of inputs and other factors of production. In terms of this scenario, discuss the type of inflation that thus could lead to. Use a digram to motivate you answer.

(Answer shoud be 2 pages long)

Expert Solution

When the firms in South Africa experience an increase in the price of inputs and other factors of production, this will lead to the Cost-Push type of Inflation.

The cost-push inflation occurs when there is an increase in the cost of production which causes the supply curve to shift to the left while the demand remains same as seen in the figure below. Demand in this case is inelastic as the prices go up but demand increases.

As seen in the above diagram, the increase in the price of inputs will increase the cost of production and which will result in increase in prices in the market which will lead to inflation.The rise in the prices of inputs may be due to various reasons such as rising oil prices,increase in tax rates.It leads to decrease in output as the supply curve shifts to SRAS2, the GDP decreases and it affects the overall market as standard of living gets affected,poor people cannot afford the daily required necessities.

The inflation makes the imports costly which results in eroding of nation's forex reserves and food prices will increase.

The government can adopt various measures to control this type of inflation,mainly adopt fiscal and monetary policy where it can reduce the taxes,or increase the interest rates which will decrease the borrowing and curb the spending thereby, reducing the demand.

Rahul Sunny answered 2 years ago

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