Assignment Economics

Assignment of Economics
Submitted by:
Taleeb Ahmad
(BSECO-21-24)
Submitted to:
Dr. Rana Adeel Farooq
Topic:(1) Which factors affect the Inflation?
Do Inflation and Exchange Rate affects each
other?
(2) How firms take Price and Quantity
decisions in Perfect Competition and
Monopoly?
Dated_Feb, 08-2023
Department of Economics
University of Sahiwal, Sahiwal
Factors that Cause of Inflation

In general, the inflation rate of an economy can be caused by various factors which
include the following:
Demand-pull inflation:
Demand-pull inflation arises when demand exceeds the supply of goods and
services in an economy. To put it simply, when supply is insufficient to meet
consumer demand, prices will go up, leading to inflation.
For example, if manufacturing tires suddenly becomes twice as expensive, the
prices of those tires will also increase, causing inflation. This could even affect the
car market, as car manufacturers will need to pay more to complete their vehicles.
Cost-push inflation:
Cost-push inflation is a result of increased costs of production due to rising labor
wages or raw material prices. This pressures manufacturers or service providers to
pass on the higher costs to their customers by raising prices of goods and services.
For example, when oil prices rise, it will increase electricity and transportation
costs, prompting suppliers to raise selling prices to accommodate higher
production costs.
Increase in Public Spending:

In any modern economy, Government spending is an important element of the total
spending. It is also an important determinant of aggregate demand.
Usually, in lesser developed economies, the Govt. spending increases which
invariably creates inflationary pressure on the economy.
Deficit Financing of Government Spending:

There are times when the spending of Government increases beyond what taxation
can finance. Therefore, in order to incur the extra expenditure, the Government
resorts to deficit financing.
For example, it prints more money and spends it. This, in turn, adds to inflationary
pressure.
Population Growth:
As the population grows, it increases the total demand in the market. Further,
excessive demand creates inflation.
Exports:
In an economy, the total production must fulfill the domestic as well as foreign
demand. If it fails to meet these demands, then exports create inflation in the
domestic economy.
Trade Unions:
Trade union work in favor of the employees. As the prices increase, these unions
demand an increase in wages for workers. This invariably increases the cost of
production and leads to a further increase in prices
Tax Reduction:
While taxes are known to increase with time, sometimes, Governments reduce
taxes to gain popularity among people. The people are happy because they have
more money in their hands.
However, if the rate of production does not increase with a corresponding rate, then
the excess cash in hand leads to inflation.
Hoarding:
Hoarders are people or entities who stockpile commodities and do not release them
to the market. Therefore, there is an artificially created demand excess in the
economy. This also leads to inflation
Non-economic Reasons:
There are several non-economic factors which can cause inflation in an economy.
For example, if there is a flood, then crops are destroyed. This reduces the supply
of agricultural products leading to an increase in the prices of the commodities.
Investment in Gold, Real estate, stocks, mutual funds, and other assets are some of
the ways to deal with Inflation.
Do inflation and exchange rate affect each other?

The level of inflation has a direct impact on the exchange rate between two
currencies on several levels:
Purchasing power parity:

Purchasing power parity attempts to compare the different purchasing powers of
each country according to the general price level (and not the exchange rate). This
makes it possible to determine the country with the most expensive cost of living.
Changes in purchasing power parity (and therefore inflation) affect the exchange
rate. If inflation is the same in both countries, the exchange rate does not change. If
it is higher in one country than in the other, this is when inflation affects the
exchange rate. The currency with the higher inflation rate then loses value and
depreciates, while the currency with the lower inflation rate appreciates on the
Forex market.
Interest rates:
Too high inflation pushes interest rates up, which has the effect of depreciating the
currency (less remunerative) on Forex. On the other hand, inflation that is too low
(or deflation) pushes interest rates down, which has the effect of appreciating the
currency on the Forex market. A high rate of inflation is likely to have a negative
impact on the exchange rate, while low inflation is far from a guarantee of an
increase in the exchange rate.
But be careful, an inflation figure alone does not mean anything. What central
banks are monitoring is changes in the inflation rate. If it continues to grow, there
is a risk of rising interest rates.
(2) How firms take Price and Quantity decisions in Perfect

Competition and Monopoly?
In Perfect Competition:
The price is determined by demand and supply in the market not by individual
buyers or sellers. In a perfectly competitive market, each firm and each consumer
is a price taker. A price-taking consumer assumes that he or she can purchase any
quantity at the market price without affecting that price.
A perfectly competitive firm has only one major decision to make — namely, what
quantity to produce.
When the perfectly competitive firm chooses what quantity to produce, then this
quantity along with the prices prevailing in the market for output and inputs will
determine the firm’s total revenue, total costs, and ultimately, level of profits.
Profit = Total Revenue – Total Cost
= Price × Quantity – Average Total Cost × Quantity
The formula above shows that total revenue depends on the quantity sold and the
price charged. If the firm sells a higher quantity of output, then total revenue will
increase. If the market price of the product increases, then total revenue also
increases whatever the quantity of output sold.
Marginal revenue and marginal cost (MC) are compared to decide the
profit-maximizing output.
⮚ If MR > MC, then the firm should continue to produce.
⮚ If MR < MC, then the firm should lower its output.
⮚ If MR = MC, then the firm should stop producing the additional unit. As the
additional unit’s MC would be higher according to law of diminishing

returns, MR would be less than MC; that is, the firm would loss profit by
producing additional units.
Perfect Competition: In a perfectly competitive market, the marginal revenue curve

is horizontal and equal to demand, or price. Production occurs where marginal cost
and marginal revenue intersect.
In Monopoly:
Monopolies have much more power than firms normally would in competitive
markets, but they still face limits determined by demand for a product. Higher
prices (except under the most extreme conditions) mean lower sales. Therefore,
monopolies must make a decision about where to set their price and the quantity of
their supply to maximize profits. They can either choose their price, or they can
choose the quantity that they will produce and allow market demand to set the
price.
Monopoly Diagram: This graph illustrates the price and quantity of the market
equilibrium under a monopoly

Assignment Economics

Uploaded by

Copyright:

Available Formats

Assignment Economics

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Assignment Economics

Uploaded by

Copyright:

Available Formats

Assignment of Economics

Factors that Cause of Inflation

Increase in Public Spending:

Deficit Financing of Government Spending:

Do inflation and exchange rate affect each other?

Purchasing power parity:

(2) How firms take Price and Quantity decisions in Perfect

⮚ If MR > MC, then the firm should continue to produce.

⮚ If MR < MC, then the firm should lower its output.

additional unit’s MC would be higher according to law of diminishing

Perfect Competition: In a perfectly competitive market, the marginal revenue curve

You might also like