While increasing demand is generally great news for an economy, a lagged supply chain can cause Inflation. In this blog post, we'll go through why this is a very real issue facing economic managers all around the world.
Firstly, what is inflation? Inflation occurs when the demand for a product/service is greater than the current supply. When this occurs, the products value will naturally rise to meet the maximum amount consumers are willing to pay for the supply available. This happens in all markets in some form or another, it's very apparent in currencies like the US Dollar and even Bitcoin while it also occurs very subtly in retail markets. As I suggested in the opening sentence, increasing demand is usually the result of a growing economy which is generally desirable, but when unmatched by the economies suppliers significant harm can come to parties affected by inflation. Here’s how:
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A gradual decrease in real purchasing power refers to the actual purchasing power to the value of the dollar, this can be a consequence as those on fixed incomes. While most employed people will gain wage increases to align with inflation many members of the economy don't have this luxury. Pensioners/retirees are a great example of a fixed income member, as they're often living on a set amount of funds supplied by their savings or a government welfare program. Therefore, when prices rise it's quite common that they will not be able to purchase the same quantity of goods/services. Effectively the value of their dollar is depreciated by the increase of cost of products.
Greater inequality is likely to occur as those with higher incomes are less affected by the movement of prices on commonly purchased goods such as groceries and other necessities. Whereas lower income households will be more sensitive to price movements as they take a greater proportion of their income. Living expenses are generally quantified on a bare necessity level, everybody needs toothpaste though a 50-cent price increase won't affect all members of the economy evenly.
A less efficient economy can be present when inflation occurs as new businesses are much more likely to engage in less efficient business practices to take advantage of abnormally high prices. When a supplier isn't required to be scrupulous of expenditure, they are far more likely to cause waste in the economy. Waste in this sense can be described as when resources are not used to create the greatest possible quantity of outputs. A business may cut corners and allow inefficiencies due to less needed concern on costs.
Weak international competitiveness is more commonly a long-term effect of inflation. As living conditions and product prices increase domestically, so does the costs of production. This is a problem in first world countries as they're unable to produce products at a low enough price point to compete on global market. Competitors in nations with cheaper costs will often outproduce and outsell first world nations due directly to their inability to compete with inflated prices.
There will be less savings in the economy, as a greater proportion of net income will be handed out to cover expenses of the now inflated prices. When the population is in a less-saving mood, the economy will generally adjust to a cash shortage. In which, banks will have less money available to loan and therefore higher interest rates are likely. This is one of a few ways that an economy can throttle itself into a stall. As interest rates rise to reduce the amount being borrowed, businesses and mortgage holders may be forced to default on their borrowings, leading to economic downturn.
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