Australian Economy – Inflation Essay

Resource Description

Explain the causes of inflation and its effects on the Australian economy. (977 words approx 38 minutes – without graphs)

Inflation is a sustained increase in the general level of prices in an economy. It’s measured by the annual percentage change in the Consumer Price Index (CPI) and since 1993 the RBA’s target inflation rate has been 2-3%. Australia is currently in its longest period of low inflation since the 1990s, with the 2019 inflation rate at just 1.7%. Understanding the causes and differences between demand-pull, cost push, inflationary expectations and imported inflation are vital in ensuring correct monetary and fiscal policies are employed to maintain an inflation target and to avoid the impacts of high inflation being income inequality, constraints on economic growth and the erosion of international competitiveness and purchasing power.

An increase in the price of goods and services can be caused by demand pull inflation. Demand pull occurs when demand for goods and services exceeds the productive capacity of firms. Consumers compete against each other for the limited goods and services available allowing companies to increase their prices; (Figure 1)

Aggregate Demand (AD) has slowed in recent years due to the budget moving from a deficit to surplus alongside stagnating household incomes. If the Government continues contractionary policies during a time of low AD, inflation can decrease, a situation that is currently occurring in Australia.

Cost-push inflation occurs when supply costs rise forcing firms to raise their prices. If the factors of production, such as wages and the prices of raw materials increase, firms will attempt to pass those rising costs onto consumers by raising the prices of their products as demonstrated by the shifting aggregate supply curve in Figure 2;

Unexpected causes of cost-push inflation include natural disasters, such as Cyclone Yasi in 2013 which destroyed 800 million dollars worth of banana crops. This unexpected cost-push inflation raised the price of bananas from $2/kg to $15/kg.