Economic Essay Example | Topics and Well Written Essays - 2000 words

Economic - Essay Example For instance, oil products in global market are becoming scarce and volatile because of the continuing crisis in the Middle East, the primary suppliers of oil products. In lieu of this, oil prices rose to its highest point in just a very short period of time while demand is getting faster. Conversely, if this oil producing countries return in their normal business term, then the production of oil products will increase, thereby bringing a stability of price. This environment is one of the current examples of inflation and deflation that is happening in reality. The main thrust of this paper is to discuss the causes of inflation and deflation, and how these affect corporate decision-making. To have a better understanding on this anomaly, it is a requirement to study the complex movements of prices and their effects through current situations and events. Inflation and Its Causes Inflation is described by Mukherjee (2002, p.26) â€Å"as a process in which the price level is rising and money is losing its value.† As you can see in figure 1, if the aggregate demand (AD) is increasing faster than the rate of the aggregate supply (AS), the general price level also increases, and this phenomenon is known as inflation. Nowadays, many countries are suffering from higher rates of inflation and sometimes government had to compromise by paying the cost of the reduced productivity. However, many economists have argued that pouring too much money into the economy as a solution would only lead to a more serious inflation (McNeese, 2000, p.22). The main causes of this phenomenon include: Too much demand in the economy. If the demand is high and the available supply cannot meet the demand, general price level would eventually move upward, thereby bringing in inflation or particularly known as demand-pull inflation. This is a situation wherein the rate of demand is faster than the rate of supply leading to a shortage of supply which means that â€Å"an increase in demand will affect prices more than output because firms may not be able to recruit staff more easily or produce more...† (Gillespie, 2007, p.381). Cost-push, monetary, and supply shock inflation. This type of inflation occurred when the supply of money in the circulation is high, causing the purchasing power of people to increase and eventually lead to a demand-pull inflation. On the other hand, cost-push inflation happened when the level of productivity among workers is increasing, labour expenses are also increased and the rate will be added up to the general price level (Grant & Vidler, 2003, p.132). Lastly, supply shock is more or less interrelated with demand-pull inflation; however, this time the supply is generally scarce. For example, the steady increase in prices of oil products in the world market brought by subsequent events particularly in Libya have also contributed to the increase of prices in almost all of the basic commodities. Deflation and Its Causes â€Å"Deflati on is a sustained decrease in the average price level of the entire economy† (Saunders & Gilliard, 2000, p.32). The steady and continuous fall of prices sound interesting to those who are not fully aware of deflation, but this term is not good for the monetary economy because falling prices would adversely affect income that eventually to bankruptcy. As sale, profit and investment fall together, producers are forced to cut