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Inflation Rise Of Prices In Goods And Services Economics Essay

The world is in the grip of soaring inflation. In recent months, Pakistan has been hard hit by inflation, reaching 24.33 per cent in July 2008, which happens to be an all-time high in the country’s history. The inflation, if it crosses the double digit, is an index of a weak economy. The inflation is caused by higher demand by consumers than the availability of consumer goods, large amount of liquidity in the banking system, devaluation and increased supply of currency notes, poor performance of agriculture sector, globally high oil prices, sources diverted towards ethanol fuel, as well as hoarding and smuggling. Heavy borrowing by the government also raises the inflation level. In sum, high inflation is said to be due to the “cost-push, demand-pull and supply reduction measures”.

The spiraling prices of commodities, especially of food and fuel. Besides, the fall in the value of money is increasing the level of poverty in the country. Power shortages have adversely affected many factories and mills. Hence, prudent economic policies could help address the rising inflationary trend and improve the affected sectors of the economy, especially manufacturing and agriculture.

INTRODUCTION

Inflation or price inflation is a rise in the general level of prices of goods and services in an economy over a period of time. It can also be described as a decline in the real value of money. a loss of purchasing power. The level of inflation in Pakistan has been persistently rising since Partition. The high levels of inflation reflect a volatile economy in which money does not hold its value for long. Workers require higher wages to cover rising costs, and are disinclined to save. Producers in turn may raise their selling prices to cover these increases, scale back production to check their costs (resulting in lay-offs), or fail to invest in future production. Many such problems have been, and still are, being faced by Pakistan. The factors leading to high levels of inflation include deficit financing, foreign remittances, foreign economic assistance, increase in wages, population explosion, black money, prices of imported goods, devaluation of rupee, etc

DEFINITION

An increase in the general price level of goods and services; alternatively, a decrease in purchasing power of the dollar. It is measured by the Consumer Price Index (CPI)

TYPES OF INFLATION:

DEMAND-PULL INFLATION

Demand-pull-inflation is a result of strong consumer demand. When many individuals are trying to purchase the same good, the price will inevitably increase. When this happens across the entire economy for all goods, it is known as demand-pull-inflation

COST-PUSH INFLATION

Cost push inflation is a type of inflation caused by substantial increase in the cost of important goods or services where no suitable alternative is available. A phenomenon in which the general price levels rise due to increase in the cost of wages and raw material.

CAUSES OF INFLATION

Decelerating Economic growth

Loose monetary policies

Output set-backs

Higher duties and taxes

Depreciating Pak Rupee

Frequent adjustments in the administered prices of 

Gas, electricity, POL (Petroleum, Oil and Lubricants) products

Frequent adjustments in support price of wheat

Political instability

It has been generally agreed by the economists that high rates of inflation and hyperinflation are caused by an excessive growth in the supply of money. Today, most economists favor a low steady rate of inflation. Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduce the risk that a liquidity trap prevents monetary policy from stabilizing the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control the size of the money supply through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements.

There are many causes for inflation, depending on a number of factors.

For example,

Inflation can happen when governments print an excess of money to deal with a crisis.

When any extra money is created, it will increase some societal group’s buying power.

As a result, prices end up rising at an extremely high speed to keep up with the currency surplus.

All sectors in the economy try to buy more than the economy can produce.

Shortages are then created and merchants lose business. To compensate, some merchants raise their prices. Others don’t offer discounts or sales. In the end, the price level rises. This is called demand-pull inflation, in which prices are forced upwards because of a high demand, and excessive monetary growth.

For inflation to continue, the money supply must grow faster than the real GDP.

Another common reason of inflation is a rise in production costs, which leads to an increase in the price of the final product.

For example,

If raw materials increase in price, this leads to the cost of production increasing, this in turn leads to the company increasing prices to maintain their profits, this kind of inflation is call cost-push inflation.

Furthermore, rising labor costs can also lead to inflation, because workers demand wage increases, and companies usually chose to pass on those costs to their customers, this sort of inflation is called wage-push inflation.

Inflation can also be caused by international lending and national debts. As nations borrow money, they have to deal with interests, which in the end cause prices to rise as a way of keeping up with their debts. A deep drop of the exchange rate can also result in inflation, as governments will have to deal with differences in the import/export level.

Finally, inflation can also be caused by federal taxes put on consumer products. As the taxes rise, suppliers often pass on the burden to the consumer; the catch, however, is that once prices have increased, they rarely go back, even if the taxes are later reduced.

REASONS OF INFLATION IN PAKISTAN

There are many reasons for the inflation in the Pakistan. The most important thing is the rise in prices of oil, gas and excise duties. The multiplier effect of the rise in oil, gas prices are levying of excise duties, sales tax on, on a number of items has greatly contributed to the cost push effect. The increase in the number of sick unit, fall in industrial productions due to strikes, electricity breakdowns cause decrease in production and lead to higher cost, thus pushing up inflationary pressure. The other reason could be the increase in utility tariffs.

The government in budget considerably increased the rates of sales tax, excise duty on a large number of items. A rise in utility tariffs has also kicked a new round of inflation in the country. The rise in support prices of the agriculture crops. The government raised the support prices of cotton, wheat, sugarcane to protect the interests of the farmers. This also has an inflationary impact on the economy. The government also increases in the direct taxes to boost up its revenues. For increasing the revenue the government is heavily relying on the taxes collected by itself on the sale of different commodities

INFLATION DURING 2000-2010

Inflation in Pakistan over the last 18 years had been fluctuating between 13.0 percent and 3.1percent.Inflation gives patterns in Pakistan from 2000’s to 2009, which reports the last five years as extremely inflationary due to expansionary monetary policy and high oil prices. The inflation rate in Pakistan was 13.04 percent in March of 2010. Inflation rate refers to a general rise in prices measured against a standard level of purchasing power. The most well known measures of Inflation are the CPI which measures consumer prices, and the GDP deflator, which measures inflation in the whole of the domestic economy.

PRICE INDICES IN PAKISTAN

Four different price indices are used in Pakistan over the course of fiscal year, namely:

The Consumer Price Index (CPI),

The Wholesale Price Index (WPI),

The Sensitive Price Index (SPI),

The GDP deflator.

The CPI is the main measure of price changes at the retail level. It covers the retail prices of 374 items in 35 major cities and reflects roughly the changes in the cost of living of urban areas. The WPI is designed for those items which are mostly consumable in daily life on the primary and secondary level; these prices are collected from wholesale markets as well as from mills at organized wholesale market level. The WPI covers the wholesale price of 106commodities prevailing in 18 major cities of Pakistan. The SPI shows the weekly change of price of 53 selected items of daily use consumed by those households The SPI is based on the prices prevailing in 17 major cities and is computed for the basket of commodities being consumed by the households belonging to all income groups combined. In Pakistan, the main focus is place down the CPI as a measure of inflation as it is more representative with a wider coverage of 374items in 71 markets of 35 cities around the country.

Table: Annual Rate of Inflation (Percentage) in Pakistan for Period 2000-2009

Period  CPI  SPI WPI

2000-2001 4.41 4.84 6.21

2001-2002 3.54 3.37 2.08

2002-2003 3.10 3.58 5.57

2003-2004 4.57 6.83 17.91

2004-2005 9.28 11.55 6.75

2005-2006 7.92 7.02 10.10

2006-2007 7.77 10.82 6.94

2007-2008 8.01 11.03 10.26

2008-2009 24.43 30.96 27.98

2010 20.77 - -

IMAPACT OF INFLATION ON ECONOMY

PAKISTAN GDP GROWTH RATE

Pakistan Gross Domestic Product (GDP) expanded 2.00% over the last 4 quarters. The Pakistan Gross Domestic Product is worth 168 billion dollars or 0.27% of the world economy, according to the World Bank. Pakistan's economy has suffered in the past from decades of internal political disputes, a fast growing population, mixed levels of foreign investment, and a costly, ongoing confrontation with neighboring India. However, IMF-approved government policies, bolstered by foreign investment and renewed access to global markets, have generated solid macro economic recovery during the last decade. This page includes: Pakistan GDP Growth Rate chart, historical data and news

PAKISTAN INTEREST RATE

Pakistan benchmark interest rate stands at 12.50 percent. In Pakistan, interest rate decisions are taken by the State Bank of Pakistan. The official interest rate is the discount rate. This page includes: Pakistan Interest Rate chart, historical data and news

ROLE OF INCOME TAX

The economy of Pakistan is the 25th largest economy in the world in terms of purchasing power, and the 45th largest in absolute dollar terms. Pakistan has a semi-industrialized economy, which mainly encompasses textiles, chemicals, food processing, agriculture and other industries. Growth poles of Pakistan's economy are situated along the Indus River, diversified economies of Karachi and Punjab's urban centers; coexist with lesser developed areas in other parts of the country. The economy has suffered in the past from decades of internal political disputes, a fast growing population, mixed levels of foreign investment, and a costly, ongoing confrontation with neighboring India. However, IMF-approved government policies bolstered by foreign investment and renewed access to global markets, have generated solid macroeconomic recovery the last decade. Substantial macroeconomic reforms since 2000, most notably at privatizing the banking sector have helped the economy.

GDP growth, spurred by gains in the industrial and service sectors, remained in the 6-8% range in 2004-06 due to economic reforms in the year 2000 by the Musharraf government. In 2005, the World Bank named Pakistan the top reformer in its region and in the top 10 reformers globally. Islamabad has steadily raised development spending in recent years, including a 52% real increase in the budget allocation for development in FY07, a necessary step toward reversing the broad underdevelopment of its social sector. The fiscal deficit - the result of chronically low tax collection and increased spending, including reconstruction costs from the devastating Kashmir earthquake in 2005 was manageable.

Inflation remains the biggest threat to the economy, jumping to more than 9% in 2005 before easing to 7.9% in 2006. In 2008, following the surge in global petrol prices inflation in Pakistan reached as high as 25.0%. The central bank is pursuing tighter monetary policy while trying to preserve growth. Foreign exchange reserves are bolstered by steady worker remittances, but a growing current account deficit - driven by a widening trade gap as import growth outstrips export expansion - could draw down reserves and dampen GDP growth in the medium term.

One of the most commonly discussed issues in economics is how tax rates relate to economic growth. Advocates of tax cuts claim that a reduction in the tax rate will lead to increased economic growth and prosperity. Others claim that if we reduce taxes, almost all of the benefits will go to the rich, as those are the ones who pay the most taxes. What does economic theory suggest about the relationship between economic growth and taxation?

Unable to sustain solid growth, Pakistan’s economy is teetering on the brink of collapse, with one-third of the population living below the poverty line. S. Akbar Zaidi writes in a paper that Pakistan’s economic instability stems in large part from low government revenue due to the elite’s use of tax evasions, loopholes, and exemptions. Without tax reform, Pakistan will continue to run an unsustainable debt and be forced to rely on Western donors for bailouts. 

Policy Recommendations

Eliminate exemptions. Fewer than three million of Pakistan’s 175 million citizens pay any income tax, and the country’s tax-to-GDP ratio is just 9 percent. By eliminating tax exemptions for the rich, politicians can fund essential social services.

Increase tax revenue. Pakistani legislators must build a consensus to tax the rich and elite if they want to match growth rates in nearby developing countries.

Spend more on development. Pakistan has spent twice as much on defense during peacetime as it has on education and health combined—this needs to change.

Stop the bailouts. Donor countries must put conditions on funding and should emphasize tax and economic reform to help Pakistan develop long-term economic plans for sustainable growth.

“Pakistan’s lack of a proper tax and revenue regime has resulted in high rates of tax evasion, burdening the country with unsustainable debt and undermining its development priorities,” writes Zaidi. “The key to the country’s economic prosperity—even its survival—is a far-reaching program of tax reform.”

ZAKAT MEANING:

The word “Zakat” is an Arabic word that shows two literary meanings i-e

i. Purification

ii. Growth

Purification:

It means the purification of soul, character, life and wealth. Zakat purifies the human soul by keeping a person away from illegal sources of earning, eliminating the love for materialism and by overcoming the sense of pride for being wealth. Wealth is dear to everyone but who spends wealth on others attains goodness and purity. As Quran says in Sura al Toubah:

“Take alms out of their property, thou wouldst cleans them and purify them thereby”

Growth:

It means that a person who pays Zakat regularly, his individual wealth as well as the community wealth keeps on growing by the blessing of the Almighty ALLAH. Moreover Allah protects the wealth on which Zakat has been paid and in this way the peace of mind of the person who pays Zakat grows.

Comprehensively,

In economics, Zakat can be technically defined as follows :

“Zakat is a transfer payment which Sahib –e – Nisab Muslims make at given rates by themselves or through the Islamic state to the poor and the needy in or after the month of Rajab.

ASSESMENT OF ZAKAT

For the assessment of Zakat, the following must be kept in view.

1. Sahib-e-nisab muslim:

A Muslim who owns and keeps in his or her possession at least 7.5 tola gold or 52.5 tola silver or cash money to the equivalent value is considered a sahib e nisab muslim . It is his compulsion to pay Zakat at its prescribed rates by Quran and Hadith.

2. Exposed and unexposed wealth:

Zakat is paid for two type of wealth i-e

Exposed wealth

Unexposed wealth

EXPOSED WEALTH is the wealth which is exposed to the society e.g. agricultural goods, camels, sheep, minerals, etc.

UNEXPOSED WEALTH is the wealth which remains unexposed to the society e.g. gold, silver, cash, liquid assets etc.

3. The rates of Zakat:

Zakat is paid at the following fixed rates.

a. Gold, silver ,cash:

For at least 7.5 tola gold, 52.5 tola silver or the equivalent value in terms of business inventories or commercial goods or cash money, the rate of Zakat is 2.5%.

INDUCTING ZAKAT IN PLACE OF INCOME TAX

Zakat is absolutely different from tax which is imposed by the Govt. the main differences are as under

1. Payment:

The payment of Zakat is a religious duty whereas the payment of tax is a national duty.

2. Imposition:

Zakat is imposed only on the Muslim members of the society whereas tax is imposed on all the citizens in proportion to their ability to pay.

3. Compulsion:

Zakat is a compulsory payment which is not remitted by anyone whereas tax though compulsory payment, yet is remittable by the Govt.

4. Rates:

In case of Zakat, the rates of Zakat payment are fixed by the Holy Quran and cannot be changed by anyone whereas, in case of tax, the rates can be changed by the govt. from time to time.

5. Collection:

Zakat can be paid individually whereas tax is collected only by the Govt.

6. Utilization:

The beneficiaries of Zakat have been clearly pointed out in the holy Quran and Zakat can not be spent by the govt. on other than beneficiaries anywhere.

7. Nisab:

Nisab of Zakat is fixed by the holy Quran whereas taxable income varies from time to time.

8. Period:

Zakat is payable after the completion of one year whereas it is not necessary for tax. Its period may be less or more than one year.

9. Sources:

Zakat is imposed on all types of goods even animals, gold and silver etc. held by the individual, whereas tax is imposed only on the income earned by various sources.

10. Objectives:

The objective of the payment of Zakat is the pleasure of Almighty Allah through financial assistance of the poor and needy whereas the objective of tax is to meet the development and non development expenditures of the society, as a whole.

11. Purification:

Zakat purifies the wealth, whereas tax does not serve this purpose.

12. Variability:

Zakat is non variable whereas the tax is usually progressive.

13. Feeling:

Zakat creates the feelings of being a member of muslim society irrespective to regional limits whereas tax creates the feelings of being a member of just single society. Thus Zakat creates universal feelings while tax creates native feelings.

14. Facilities:

Tax payers expect to avail some specific facilities from the govt. against the payment of tax whereas Zakat payer does not expect to get any type of specific facility or material gain.

15. Regional limits:

Tax can be utilized just in that region from where it has been collected whereas; if the amount of Zakat is more than the needs of one region it can be spent on any other region of the world.

16. Ability to pay:

Zakat is imposed just on those who have the ability to pay it whereas tax, particularly in the case of indirect taxes can be imposed on those who have not the ability to pay.

17. Corruption:

In the collection and distribution of Zakat, there is no corruption whereas a lot of corruption is observed in the collection of tax.

SURVEY REPORT:

CONCLUSION

Keeping in view the above whole discussion on the topic of Zakat, we reach to the conclusion that Zakat is one of the five pillars of Islam. It is the main tool of fiscal policy of an Islamic state. It provides financial assistance to poor persons raises the aggregate growth of the economy, plays a vital role to stabilize all the fiscal variables and make the country prosperous.

RECOMMENDATIONS

The Government should revisit the economic policies

The State Bank of Pakistan should decrease the high interest rate in an effort to decrease the inflation.

The Government should stop borrowing money from the State Bank.

The Government should reduce or remove the taxes on food items in order to give relief to the poor people.

The Government should take suitable measures to increase the direct foreign investment. Inflation is not something which happened overnight.

There should be a political stability in the country and only then we can improve the state of our economy.

If our economy is on the right track only then we can fight the menace of terrorism and extremism.

If our economy is on the right track only then we can solve all the problems we have in our society

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