Global Economics - Essay Example

Global Economics Inflation Inflation is the rise in the general price levels of commodities in an economy. Inflation leads to a decline in purchasing power of a nation due to reduction in value for money. There are various causes of inflation which depend on demand and supply factors. Supply factors of inflation include those causes of inflation that emanate from the supply side of the economy. Cost push inflation emanates from the supply factors. Cost push inflation arises when firms react to increasing production costs by increasing the prices with an aim of sustaining their profit margins. There are various reasons which may lead to increase in costs. The first reason includes the rising costs of imported raw materials possibly caused by inflation in nations that heavily rely on exports of these products. Also, a fall in value of a country’s currency in the foreign exchange markets increases the price of imported inputs of that country (Wessels 235). The second is the rising costs of labor; this is caused by an increase in wages which exceed and enhancement in productivity. Labor intensive firms are largely affected by this cause. Firms may not be able to absorb higher wage expenditures; thus, they pass the costs to customers. As a result, the wage inflation increases the price inflation. Thirdly, the imposition of higher indirect taxes by the government. An example is the increase in the excise duty rate, VAT, standard rate or fuel duties. These taxes are charged on manufacturers who, depending on the supply for their commodities and price elasticity of demand, may decide to pass on the tax burden onto consumers (Arnold 116). Demand factors of inflation comprise those causes of inflation which originate from the demand side of the economy. Inflation arising from demand factors is known as demand pull inflation. Demand pull inflation is possible when short run aggregate supply curve is inelastic and when there is total utilization of resources. In these situations, an increase in Aggregate Demand (AD) will result to an increase in prices. Several factors may lead to a rise in AD. This may include exchange rate depreciation that has the consequence of increasing import prices and reducing the export prices (Baumol & Blinder 198). A reduction in taxes increases the real disposable income of consumers; this leads to increase in demand. Growth of the money supply, expansionary fiscal and monetary policies lead to increase in money supply in the economy. This causes an increase in demand of commodities in the economy. Imports increase causes an increase in the money supply of an economy. Increase in money supply results to an increase in demand of commodities (Arnold 119). The impact of inflation on firms and households depends on whether inflation is unanticipated or anticipated. In anticipated inflation, individuals and firms are capable of making accurate forecasts of inflation; they may take steps to guard themselves against its consequences. In unanticipated inflation, the volatility of inflation makes it seem difficult for individuals and firms to predict the inflation rate. An extremely high rate of inflation adversely affects the economy. In most developing economies, the inflation rate is negatively correlated to output growth. A rise in inflation leads to low level of savings since it reduces the real value of savings (Mankiw 140). Inflation may get out of control since price increases result in high wage demands. Firms increase the prices to sustain profits and these prices put further pressure on wages. This process is called “wage-price spiral.” The uncertainty caused by increasing inflation of costs and prices affects the firms’ planning and budgeting processes. This may lead to reduction in planned capital investment spending thereby affecting the long run productivity of the economy (Mankiw 140). Inflation is one of the causes of high rates of unemployment in the medium term. Moreover, if one nation experiences a higher inflation rate than the other, this will lead to loss of global competitiveness and, subsequently, worsening the trade performance. Economies of Scale Economies of scale refer to cost benefits realized through long run expansion of the scale of production. The effect is the reduction of the long run average expenditures over a range of output. Internal economies of scale occur from the long term growth within a firm. There exist several examples of internal economies of scale. The first includes technical economies of scale relating to the aspects of production. Large-scale firms may afford to invest in expensive capital inputs which reduce long run average costs. There is a specialization of the workforce in larger firms where the production process is divided to boost productivity. Another example includes learning by doing; in this case, the average costs of production decrease in real terms due to production experience as firms reduce waste and obtain the most productive ways of generating output on a larger scale (McEachern 160). In marketing economies of scale, a bigger firm may spread its marketing and advertising budget over a great output. It may also buy its raw materials in bulk at discounted prices. In financial economies of scale, financial markets frequently consider bigger firms to be more creditworthy than smaller firms. This enables these firms to access credit facilities at favorable rates. Companies quoted on the stock market may raise additional capital at low costs through the sale of equities to the capital market. A managerial economy of scale is a type of division of labor. For example, large-scale producers hire specialists to administer production systems. Excellent management and augmented investment in human capital and use of specialized equipments such as information systems will elevate productivity and thus reduce unit costs (Boyes & William 145). External economies of scale arise outside a firm and are experienced in the entire industry, especially when there is an expansion in the scope of an industry’s operations. For example, the construction of an improved transportation network will result in reduction of cost for a firm within that industry. The expansion of research and development facilities in domestic institutions may benefit the numerous firms within that region. The relocation of raw materials suppliers and business support services near to the manufacturing centre will result in external saving of costs. Agglomeration economies can also occur from the clustering of identical firms in a distinct geographical region. Clustering of firms may lead to growth of a pool of skilled labor due to training of workers by local firms. This provides a larger and flexible labor market in the region (Boyes & William 148). Works Cited Arnold, Roger. Economics. New York; Cengage Learning, 2008. Print. Baumol, William, and Alan Blinder. Macroeconomics: Principles & Policy. New York: Cengage Learning, 2011. Print. Boyes, William, and Michael Melvin. Microeconomics. New York: Cengage Learning, 2010. Print. McEachern, William. Economics: A Contemporary Introduction. New York: Cengage Learning, 2011. Print. Mankiw, Gregory. Macroeconomics. New York: W H Freeman, 2006. Print. Wessels, Walter. Economics. New York: Barron’s Educational Series, 2006. Print. Read More