Stability in an Economy - Term Paper Example

21 March Importance of Price Stability in an Economy with respect to Inflation and High Rising Prices No consumer on this planet would like a situation of dealing with fluctuating prices with respect to the goods and services sold in the market. Stable prices eliminate all kinds of doubt and confusion on the part of the customer, while making it important for the producer to fix his costs and bring about cost effectiveness while trying to retain a certain amount of profit. In an economy, general price levels when stable are of keen interest to the consumers, thus. However, actual price stability refers to a situation when the prices of the goods and services do not change for a prolonged period of time. The general price level remains low or affordable to the average consumer and stays that way for a long period of time. Thus, stability of prices within an economy is more of a concept than anything else. Moving on to the demand for and supply of goods in the market, there might be a number of fluctuations with regard to the customer’s needs and wants as well as the producer’s. This makes it a little difficult for the overall price values within the market or economy to be comprehended with ease by both parties. And therefore, for this purpose, a general price level or the concept of price stability is adopted in order to reflect the entire impact that the market has had on each of the different and individual units. Thus in order to understand better, price stability is simply a term or concept used to realize the stability or balance that the general price level or market forces have rather than the actually fixed prices on goods and services in the market. Price stability may also be understood as a period in the economy when it does not face inflation or deflation. In order to understand this, the term inflation has been emphasized upon in this paper. Inflation takes place in an economy when the actual aggregate demand within the economy is greater than the required level of aggregate demand for full employment equilibrium. Full employment equilibrium on the other hand is a situation when all the resources within an economy have been utilised in a full and efficient manner, and the demand curve cuts the 45 degree line or supply curve at this point. However, if the demand curve exceeds the point of full employment equilibrium, it leads to an inflationary gap in the economy. This has been better explained with the help of a diagram; Here the C+I (Total consumption plus investment expenditure) is the aggregate demand (point B) which should have been the situation for an ideal level of equilibrium in the economy and the E=I (Savings and investment) is the supply curve at 45 degrees. But the output has moved from Y to Y1 because of the rise in demand with respect to the actual demand required, thus causing an inflationary gap in the economy. Inflationary Gap in the Economy Therefore, in an inflationary situation, the general prices within the economy keep on rising and the economy thus has a negative impact as the prices of goods and services rise beyond the expectations of the consumers leading to a lot of problems in purchasing as their personal purchasing power is reduced. During a period of inflation, some of the steps that a government may take in order to bring the situation back in control are increase government spending or expenditure on the public, and reduce the level of taxes in the economy. In the United Kingdom, the rate of inflation within the economy was quite rampant in 2008 as it rose to 3.6% however, due to an economic collapse and meeting of actual aggregate demand levels, it went down to 0.4% and was expected to be about 0.8% in 2010. By the end of 2008, it was said to have the 58th lowest inflation rate in the world. The various attributes for measuring the level of inflation in an economy are either the GDP deflator which has a nominal and real GDP, or the Consumer Price Index which uses constant as well as current prices. During a period of inflation, the economy witnesses a high rise or boom stage as opposed to the period of depression it goes through during deflation. If this boom is not monitored properly it goes to a stage of recession within the economy; a notable recession that took place in 2008 was a result of the same, and had an adverse impact on the financial aspects of the world’s economies. After a period of depression, the economy turns into a period of recovery which then further leads to a boom if prices are not fixed and managed at a timely level. The main reason again is the need and deliverance of actual vs. aggregate demand within the economy. In terms of the monetary policy, inflation may be controlled by reducing the interest rates at which loans are advanced to the general public. In order to keep this in check, very low but positive inflation rates are suggested for an economy to thrive because a deflationary situation is very dangerous for economic health. Moreover, fixed exchange rates are also plausible for maintaining the rate of inflation within an economy as fixed exchange rates are used to stabilize or balance the value of a domestic currency with respect to a foreign currency. Therefore, even though a period of inflation or an inflationary gap in the economy is a situation held for a temporary period of time, it should not be taken lightly as it leads to dire consequences; the most negative of impacts falling on the consumers as well as producers in simple demand supply language. High prices lead to a lot of problems within the economy with the purchasing power of the people stooping even lower, and more so especially for those belonging to the lower income brackets. The government can take certain measures in order to correct the level of inflation with the help of monetary and fiscal policies which must be reviewed from time to time in the annual plans and budgets. In terms of macroeconomics, every economy thus has to learn to reach a situation to acquire its resources in full and not let anything be idle or waste leading to inflation or deflation, but instead keep the general prices stable on an overall basis. Works Cited UK Economic Indicators: UK GDP, UK Interest Rates, UK Inflation Rates, UK Unemployment Rates, UK Economic Data." Economy Watch. Web. . Ratnayake, Menaka. "Economy: Why Price Stability Is Important." Helium : Political & Economic Theory (2010). 6 Jan. 2010. Web. 21 Mar. 2011. . “Importance of Price Stability.” Web. 21 March 2011. Read More