Question

engineering economic

plese. clear hand writing

1- Describe the impact of inflation to the value of currency and economy of country. What is the different between inflation and deflation?

Answer 1

Inflation is reffered to the increase in the general price level in the economy. And the impact of inflation on currency and the economy is negative in a sense that a high inflation is not good a economy or the value of currency. Let's understand this with an example.

Suppose a basket of good this year costs $100 and the inflation rate is 10% for that year. Which means the $100 bakset of good will cost $110 next year or in other words your same $100 in no more able to buy that basket of good. So the purchasing power of money has gone down with inflation.

Let's understand how the inflation affects the economy of a country. As we saw above high inflation reduced the purchasing power of money. And suppose that the total income of the country is Y and the price level is P. So the total amount of goods and services that people will be able to buy will be equal to,

= Y/p

And now with 10% rate of inflation the price level will become

= P + 0.1P

= 1.1P

So in the next year the same amount of income will be able to buy,

= Y/1.1P goods and services which as you can see is less than the Y/P. So what inflation does by reducing the purchasing power of money is it reduces the real income of the individuals in the economy such that the aggregate demand in the economy falls and as result the aggregate output and income also falls.

As we discussed earlier inflation is the rise in the general price level in the economy. And on the other hand deflation is the decrease in general price level in the economy. Which is nothing but a negative inflation in which price level instead of increasing it decreases.Which means under deflation the purchasing power of money increases.

I hope I was able to help you, thank you.