IB Economics- Internal Assessment

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Bringing down the spiraling inflation

Title of the
article

Source of the
article

Date the Article

was published

The Reporter
http://www.thereporterethiopia.com/index.php/editorial/item/
3626-bringing-down-the-spiraling-inflation (accessed:
02/07/15)

13 of June 2015

Date the
commentary
was written

5 of July 2015

Word count
(750 words
maximum)

721

Section of the
syllabus the
article relates to

Section 2: Macroeconomics

Complete Article

Bringing down the spiraling inflation

The national inflation rate, which has been relatively stable, has picked up again
thanks to an escalation in the prices of both food and non-food items.
Consequently, a sizable segment of the public is approaching the end of its
tether.
The May 2015 Country Level Inflation Rate report published by the Central
Statistical Agency (CSA) last week bears testimony to this fact. According to the
report, the May 2015 general year-on-year inflation increased by 9.4 percent
over the figure registered in May 2014. It attributes the rise to the fact that the
general consumer price index (CPI) of 141.3 percent witnessed during the
month was higher than the corresponding 129.1 percent CPI seen in May 2014.
The year-on-year food inflation soared by 10.1 percent in May 2015 relative to
the same month in 2014.
The report indicates that the country-level overall inflation rate (annual change
based on 12 months moving average) rose by 7.5 percent in May 2015 in
comparison to the one observed during a similar period a year ago. A
breakdown of this figure shows a 6.9 percent and an 8.2 percent hike,
respectively, in the price indices of food items and non-food items.
The report further notes that most of the food indices ticked upward in May
2015 courtesy particularly of a rise in the prices of meat, milk, cheese and eggs,
oils and fats, sugar, vegetables, pulses (specially lentils) fruits and spices
(specially pepper whole). The non-food inflation also increased by 0.7 percent
mainly due to an upsurge in the prices of qhat, clothing and footwear,
construction materials (especially cement), firewood as well as household
goods and furnishings. However, there was a 0.9 percent fall in the inflation rate
of bread and cereals due to a slight decline in the prices of maize, sorghum and
wheat. The transport indices also declined
The report clearly affirms that the rise in inflation is making life difficult for many
because their income simply cannot keep up with price rises. Though the
federal government has intervened and is subsidizing the prices of basic
commodities like wheat, flour and edible oil, the chaos that characterizes the
market needs to be brought to heel. While we are not advocating here a return
of the command economy which allows the government to set prices, there can

be no denying that the market has to be regulated in a way that fosters

competition and protects the interest of consumers.
One of the principal factors behind the spiraling cost of living is the
monopolization of the market by a handful of players. It is impossible to talk
about a free market while prices and the distribution of goods are fixed by
cartels. A market which should be governed by the laws of demand and supply
has been distorted by the proliferation of rent-seekers in the value chain
beginning from importers/wholesalers to retailers. Consequently, consumers are
suffering much at the hands of a few who are able to manipulate the market
with caprice.
This brings us to what use, if any, consumer cooperatives and governmentowned retail enterprises have had in achieving their stated objective of
stabilizing prices. These entities by and large have not succeeded in protecting
consumers from artificial price escalations which are devoid of economic
justification. In fact most of them have fallen under the control of greedy rentseekers and are complicit in the very price rise they are supposed to curb. What
is the value of their existence if they are actually working against consumers
interest? Hence, they should either shape up or close up shop.
Its not these entities alone who are at fault, though. The regulatory agencies
tasked with ensuring that the market functions healthily are also guilty of not
discharging their responsibilities with the required determination and integrity.
Aside from food items, the inexorable rise in house rent, medical expenses and
tuition fees is also breaking the back of citizens. With more than half of their
monthly income eaten up by house rent, numerous hardworking families are
finding it extremely challenging to make ends meet with the remainder eking out
a miserable existence. Although it would be wrong and ultimately futile for the
government to set price caps, isnt it possible to adopt policies which
accommodate the interests of both consumers and those who sell goods and
services to them? We believe this is within the reach of the government and
other stakeholders.
The governments avowed mission to make Ethiopia a middle-income country
within two decades must be anchored in the citizens who are contributing their
due share to this sacred endeavor. After all it is unthinkable to build a nation fit
to live and work in for coming generations while the present generation leads a
wretched life. It is incumbent upon the government to utilize all the resources at
its disposal to put an end to the unruly nature of the market that is causing
countless citizens to pay a hefty price.
To sum up, inflation is beginning to inch up again after a relatively stable period.
Therefore, it is imperative that all of us do whatever is in our power to roll back

the increase or at least stop it in its track. Otherwise, it will exacerbate the
already difficult condition low- and middle-income citizens are living in.

Section Used:
Bringing down the spiraling inflation
The national inflation rate, which has been relatively stable, has picked up again
thanks to an escalation in the prices of both food and non-food items.
Consequently, a sizable segment of the public is approaching the end of its
tether.
The May 2015 Country Level Inflation Rate report published by the Central
Statistical Agency (CSA) last week bears testimony to this fact. According to the
report, the May 2015 general year-on-year inflation increased by 9.4 percent
over the figure registered in May 2014. It attributes the rise to the fact that the
general consumer price index (CPI) of 141.3 percent witnessed during the
month was higher than the corresponding 129.1 percent CPI seen in May 2014.
The year-on-year food inflation soared by 10.1 percent in May 2015 relative to
the same month in 2014.
The report indicates that the country-level overall inflation rate (annual change
based on 12 months moving average) rose by 7.5 percent in May 2015 in
comparison to the one observed during a similar period a year ago. A
breakdown of this figure shows a 6.9 percent and an 8.2 percent hike,
respectively, in the price indices of food items and non-food items.
The report further notes that most of the food indices ticked upward in May
2015 courtesy particularly of a rise in the prices of meat, milk, cheese and eggs,
oils and fats, sugar, vegetables, pulses (specially lentils) fruits and spices
(specially pepper whole). The non-food inflation also increased by 0.7 percent
mainly due to an upsurge in the prices of what, clothing and footwear,
construction materials (especially cement), firewood as well as household
goods and furnishings. However, there was a 0.9 percent fall in the inflation rate
of bread and cereals due to a slight decline in the prices of maize, sorghum and
wheat. The transport indices also declined

The report clearly affirms that the rise in inflation is making life difficult for many
because their income simply cannot keep up with price rises. Though the
federal government has intervened and is subsidizing the prices of basic
commodities like wheat, flour and edible oil, the chaos that characterizes the
market needs to be brought to heel. While we are not advocating here a return
of the command economy which allows the government to set prices, there can
be no denying that the market has to be regulated in a way that fosters
competition and protects the interest of consumers.
One of the principal factors behind the spiraling cost of living is the
monopolization of the market by a handful of players. It is impossible to talk
about a free market while prices and the distribution of goods are fixed by
cartels. A market which should be governed by the laws of demand and supply
has been distorted by the proliferation of rent-seekers in the value chain
beginning from importers/wholesalers to retailers. Consequently, consumers are
suffering much at the hands of a few who are able to manipulate the market
with caprice.

Commentary
An alarming inflation, which is the economical situation in which prices
constantly increase, is a situation difficult to overpass. The country of Ethiopia,
on the 1st of June of this year, managed an inflation of 9.4%, obtaining the
highest inflation since January 2013 (KPMG, 2015) 1. This inflation rate
negatively affects the economy.
Through the information in the article, one can infer the Ethiopian inflation is
cost-push inflation or one in which prices increase due to higher costs and/or a
decrease in AS. As mentioned in the article, there is an oligarchy (the situation
in which few firms control the market), and this allows them to manipulate
supply.

1 KPMG (2015). 2015 Quarter 1. Monitoring African Sovereign Risk

Diagram 1
An oligarchy can manipulate AS, as seen in the diagram above, where the
aggregate supply is initially at AS1. The increase in price from the cartels will
increase the profits of the firms; a raise in the costs will cause the SRAS to shift
from SRAS1 to SRAS2. Initially, the equilibrium point is at Y1=P1. However, the
shift caused by the cartels will unbalance the market. The shift will create a lack
of supply from Y1-Y3, creating a pull-cost inflation and raising the price to P2.
Then, firms can manipulate the supply of the market and with it, the prices of it.
Nonetheless, this pull-inflation will affect in the short run. In the long-run, the
government needs to supply the people with commodities. The cost-push
inflation has created spiral inflation, one which is constantly increasing. Firms
will have to increase the prices to maintain the profits with the higher costs, but
these higher prices indirectly create even higher costs, creating a cycle. The
workers will not be able to pay the new higher prices, forcing the government to
distribute commodities to avoid a famine. Since the workers cannot pay for
products and the government is delivering products at a different price than the
equilibrium one, the AD will be affected. This scenario will happen in the longrun, represented in the diagram 2 with the use of the Keynesian LRAS.

Diagram 2
(Diagram 1 and Diagram 2 are not in the same scale)
In the diagram, the equilibrium point is at P1=Yfe. The diagram supposes the
Ethiopian economy is at a point close to full employment (although this is not be
true). The AD will be affected by the factors previously mentioned, shifting the
curve to the right. The government, through the distribution of products, will
have boosted the demand, shifting the AD to AD1. However, the LRAS will have
reached the maximum real national output it can produce. Therefore, price will
increase from P1 to P2, creating demand-push inflation or inflation generated by
demand factors. The AD of the Ethiopian economy strongly outweighs the
aggregate supply. In fact, one can speculate that the economical sequels from
this inflation will make more suppliers withdraw from the market, lowering down
the supply and increasing even more inflation.
Instability will increase, making the savings decrease; therefore, the circular
flow of income will have more money in circulation. Higher expenditure by
consumers and by the government shifts the AD to points which are not
supported by the AS. This causes the spiral inflation to potent.
The State can either affect the free market and prohibit oligarchies or try to
reduce the inflation through an exchange of inflation for unemployment.
According to the Philips Curve, a high inflation will mean low unemployment.

Diagram 3
A high percentage of inflation will generate a low percentage of
unemployment, relative to the level of inflation. At point of inflation I, the
unemployment of Ethiopia will be U1. The workers have already started to
predict the levels of inflation; they now acknowledge that their real wages do not
increase as inflation increases. Workers will leave their firms to find one which
pays according to the level of inflation. This increases the unemployment to U2.
The spiral inflation in Ethiopia does not only increase prices, but generates
unemployment in the long-run. According to Friedman, there is no long-run
trade-off between inflation and unemployment.
Ergo, the article and this commentary try to finally demonstrate that the
power which oligarchies and cartels have can be massive. The decisions which
firms make to potent their revenue can turn apart an economy, and affect its
citizens.
Word Count: 721
Bibliography:
Primary source:
The Reporter (2015). Bringing down the spiraling inflation. The Reporter
Ethipia. Accessed on the date: 01/07/2015. From the website:

www.thereporterethiopia.com/index.php/editorial/item/3626-bringing-down-thespiraling-inflation
Secondary sources:
1. KPMG (2015). 2015 Quarter 1. Monitoring African Sovereign Risk. Accessed on the
date: 05/07/2015. From the website: www.kpmg.com/Africa/en/KPMG-inAfrica/Documents/2015%20Q1%20Snapshots/KPMG_Ethiopia%202015Q1.pdf

2. Trading Economics (2015). Ethiopian Inflation Rate. Trading Economics. Accessed

on the date: 05/07/2015. From the website: www.tradingeconomics.com/ethiopia/inflationcpi