ECO401 - Economics 2nd GDB Solution Semester 2014

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ECO401 - Economics 2nd GDB Solution Semester 2014

Total Marks 20

Starting Date Wednesday, January 29, 2014

Closing Date Friday, January 31, 2014

The Case:
Containing inflation is not easy and stabilizing prices of essential food items is even more difficult. In Pakistan, effective monitoring of food prices is nowhere in sight. Repeated warnings by officials against profiteering fall on deaf ears. When supplies are disrupted, prices move up. Food inflation peaked in FY11 to 18% against aggregate (total) CPI inflation of 13.7% because in that year, super floods had washed away pulses, vegetables and other minor food crops and wrecked farm to market transportation. Sowings and harvests of wheat, rice, maize and sugarcane were also hit. The very next year, food inflation equaled overall inflation of 11% as supplies had improved after increase in crop harvests and improvement in logistics. In the last fiscal year too, food inflation of 7.4% was slightly higher than the general inflation of 7.1%. But in six months of the current fiscal year, increase in food prices has been higher than increase in CPI inflation as a whole, 9.9% against 8.9%. According to latest inflation report of State Bank of Pakistan (SBP), prices of 17 out of 20 food items went up in December with year-on-year increase ranging between 2% in case of sugar, to 78% in case of onions. Reports of previous five months had painted almost identical picture of prices of essential food items. According to Pakistan Bureau of Statistics (PBS), food inflation in small towns and villages rise faster than in major cities, it essentially means supplies are really scant. It also means that in the given period, cost of transportation of some food items from cities to rural areas has been higher than intra-city transportation cost. There is even huge difference in the prices of rice, wheat flour, sugar, pulses, fish, eggs and poultry meat in various parts of the country. Retail food prices also vary among various cities and even between different markets of the same city. Some food items like vegetables, fruits and pulses show erratic changes in prices also because they are perishable. Not only Pakistan, but other countries in the region like India, China, Bangladesh and Sri Lanka have lately experienced abnormal rise in prices of onions and potatoes simply because a late or faulty assessment of crop shortage made it difficult for them to compensate supply gaps with imports.

Requirement:
Being a student of Economics, carefully analyze the above case and think over the factors that cause a huge difference in the prices of food items in various parts of the country. What measures should be taken in order to control the food inflation as a whole? Discuss logically.

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Start Disscusion Students

[Vuhelper]

There are various reasons of price in food items in different cities of a country

As we know that , Inflation is defined as a rise in the general price level. In other words, prices of many goods and services such as housing, apparel, food, transportation, and fuel must be increasing in order for inflation to occur in the overall economy.

so two most important factors are causing this issue .

Demand-Pull Inflation and Cost-Push Inflation. Both types of inflation cause an increase in the overall price level within an economy.

Demand-pull inflation

1.Demand-pull inflation for food prices occurs when aggregate demand for food items in an economy rises more rapidly than an economy’s productive capacity. See Chart 1 for an illustration of what will likely happen as a result of this shock. The increase in money in the economy will increase demand for food products from D0 to D1. In the short run, businesses cannot significantly increase production and supply (S) remains constant. The economy’s equilibrium moves from point A to point B and prices will tend to rise, resulting in inflation.


Cost-push inflation, on the other hand, occurs when prices of production process food inputs increase. Rapid wage increases or rising raw material prices are common causes of this type of inflation. The sharp rise in the price of imported oil during the 1970s provides a typical example of cost-push inflation (illustrated in Chart 2). Rising energy prices caused the cost of producing and transporting goods to increase which ultimately became the reason of the high prices of various products of food in Pakistan. Higher production costs led to a decrease in aggregate supply (from S0 to S1) and an increase in the overall price level because the equilibrium point moved from point Z to point Y.

3. other reasons are

i Feudalism in terms of paying low wages to farmers and middle men.

ii transportation cost as i have mentioned earlier

iii unequal distribution of land which causes to produce only few food items and then those prices rise to maximise the utility as well as to maximise the profits.

iv imported goods are another reason which include higher tax rates ( tariffs ) which lead the high food prices.

(In my point of view , these are the reasons which are increasing the food items and hence the overall inflation.)

[Vuhelper]

WHAT IS THE BEST WAY TO CONTROL INFLATION?

It depends on what is driving the inflation. If it is an excess of money supply, then the answer is to increase interest rates, increase bank reserve requirements, and to sell government securities to the banks. These measures also work if the inflation is caused by rising import prices at times when the Indian currency is falling. Fiscal policy can also contribute to lower demand and money supply by increasing taxes.

If it is from excessive government demand, then the answer is for the government to reduce spending. If from excessive consumer demand then the government can introduce policies that promote saving over spending.

If it is caused by demographic factors, such as large family sizes and a lot of young people as a percentage of the population, then policies that encourage smaller families will be effective.