Types of inflation

There are several ways of defining inflation. In some contexts it refers to a steady increase in the supply of money. In others it is seen as a situation where demand exceeds supply. It seems best, however, to define inflation as a situation in which the general price level is constantly moving upwards.

In the extreme form of inflation, prices rise at a phenomenal rate and terms such as hyperinflation, run-away inflation, or galloping inflation have been used to explain the situation. Germany experienced this kind of inflation in 1923 and by the end of that year prices were one million times greater than their pre-war level. Towards the end of 1923, paper money was losing half or more of its value one hour, and wages were fixed and paid daily.

Under conditions of hyperinflation people lose confidence in the currency's ability to carry out its functions. It becomes unacceptable as a medium of exchange and other goods, such as cigarettes, are used as money. When things have become as bad as this the only possible course of action is to withdraw the currency and issue new monetary units.

Another type of inflation is described as suppressed inflation. This refers to a situation where demand exceeds supply, but the effect on prices is minimized by the use of such devices as price controls and rationing. The excess demand still exists and it will tend to show itself in the form of waiting lists, queues, and black markets.

The most common type of inflation is creeping inflation where the general price level rises at an annual rate between 1 and 6 percent.

Competition

The more competition there is, the more likely are firms to be efficient and prices to be low. Economists have identified several different sorts of competition. Perfect competition is the most competitive market imaginable in which everybody is a price taker. Firms earn only normal profits, the bare minimum profit necessary to keep them in business. If firms earn more than this (excess profits) other firms will enter the market and drive the price level down until there are only normal profits to be made.

Most markets exhibit some form of imperfect or monopolistic competition. There are fewer firms than in a perfectly competitive market and each can to some degree create barriers to entry. Thus firms can earn some excess profits without a new entrant being able to compete to bring prices down.

The least competitive market is a monopoly, dominated by a single firm that can earn substantial excess profits by controlling either the amount of output in the market or the price (but not both). In this sense it is a price setter. When there are few firms in a market (oligopoly) they have the opportunity to behave as a monopolist through some form of collusion. A market dominated by a single firm does not necessarily have monopoly power if it is a contestable market. In such a market, a single firm can dominate only if it produces as efficiently as possible and does not earn excess profits. If it becomes inefficient or earns excess profits, another more efficient or less profitable firm will enter the market and dominate it instead.

MONEY

Money makes the world go round and comes in many forms, from shells and beads to gold coins to plastic or paper. It is better than barter in enabling an economy’s scarce resources to be allocated efficiently. Money has three main qualities:

• as a medium of exchange, buyers can give it to sellers to pay for goods and services;

• as a unit of account, it can be used to add up apples and oranges in some common value;

• as a store of value, it can be used to transfer purchasing power into the future.

A farmer who exchanges fruit for money can spend that money in the future; if he holds on to his fruit it might rot and no longer be useful for paying for something. Inflation undermines the usefulness of money as a store of value, in particular, and also as a unit of account for comparing values at different points in time. Hyper-inflation may destroy confidence in a particular form of money even as a medium of exchange. Measures of liquidity describe how easily an asset can be exchanged for money (the easier this is, the more liquid is the asset).