What is inflation?

Inflation means a sustained increase in the average or general price level in an economy. This means that the price level of the vast majority of the goods keeps on rising.

Inflation is one of the many economic problems facing Maldives.

There are several causes of inflation. The most noticeable factor behind inflation in Maldives is the exchange rate.

Causes of inflation

Inflation happens when too much money chases too few good and services. This is a concept agreed by almost all the economists today. This also matches the demand theory of the inverse relationship between the quantity demanded the the price, and the direct relationship between quantity supplied and the price.

Let’s see what happened in the Maldives. The lifting of the peg led to an immediate depreciation of Maldivian Rufiyaa against the US$.

The depreciation affected all the imports. Imports became expensive. Most of the goods at the market are imported goods, therefore the general price level in the shops in Male’ showed an immediate spike.

Exchange rate also affected the prices of locally produced goods too. The reason is the rise in the price of petrol and diesel.

The shop owners are clever too, they even charged the new prices on the stock they purchased when the US$ was still at the old exchange rate.

Now let us see the general causes of inflation

Demand-pull inflation

An increase in the aggregate demand in the economy will cause inflation if the suppliers are unable to increase supply to match the increase in demand.

Increase in income of the consumers, reduction in taxes, and increase in government spending are some of the reasons of demand-pull inflation.

Cost-push inflation

Rising in the prices of raw materials and other costs of production will make the producers and suppliers charge higher prices in-order to cover the increased costs.

Cost-push factors

Cost-push refers to the costs that a business has to meet, such as wages and raw materials. As costs rise, the business will often pass these on to consumers by increasing the prices for the product they are selling.

Food costs
The most significant rise in price in Maldives is seen on food items. This is largely due to the fact that Maldives imports much of the food items consumed by the people. As costs are given quite a high weight, increase in price of food items are felt more by the people.

Raw material costs
Despite the world recession in 2008 and 2009, the costs of raw materials such as steel, copper, oil and gas have risen. These raw materials are at the centre of modern economies, so as their prices rise, there is an effect on many other prices.

Wage costs
Wage costs are another major cause of cost-push infl ation. If food and fuel prices rise, people will press their
employers for higher wages. If, however, the wage increase is not matched by higher labour productivity, in other words, if the workers do not produce more goods to sell, production costs will rise.

Land costs
Land prices in many countries have risen as land is used more intensively. For example, the increase in rent in Male’ has led to the shop owners increase prices of the items they sell, in order to recover the increased expenses. The prices of meals served at the restaurants have also increased dramatically due to high rent.

Inflation in Maldives is partly cost-push. The increase in fuel prices lead to higher costs on electricity generation and transport. Therefore the costs of the farmers in agricultural islands have also increased. This is the reason why even the prices of domestically produced food items have gone up due to depreciation of Maldivian Rufiyaa against US Dollar.

The costs of inflation

Inflation affects the ‘real income’ of the people. Real income means what the money income can actually buy. With the increase in prices and the money income remaining the same, the people actually are poorer in real terms.

Inflation is a major problem faced by economies. As the price level increases, the workers usually tend to demand for higher wages. Sometimes this even leads to strikes and violent riots on the streets.

Will the increase in wages solve the problems?

Mostly no! The increase in wages will again increase the cost of production and the money that is able to chase the available goods, leading to still more inflation.

Therefore governments tackle with the problem with caution. Increasing the productive capacity is required to reach a long term and sustained solution.

Next Topic: Deflation

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