welfare effects of inflation

8/14/2019 Welfare Effects of Inflation

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P.L. Mohapi & R.I. ThamaeNUL Economics Department

Welfare Analysis of Food andWelfare Analysis of Food and

Energy Inflation:Energy Inflation:A Representative Agent Approach withA Representative Agent Approach with

the Lesotho Working Classthe Lesotho Working Class


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Introduction

While inflation is part of life, everyone wouldagree that 2008 was a really bad year for the

consumer.

The Inflation Concept Headline Inflation

Core Inflation

Components Inflation

Focus on Components Inflation

Food and Energy


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Introduction (cont.)

What does the study actually investigates?Two things:

4. The impact of 2008 components inflation on the

representative/average workers standard of living.

This is measured by the workers proportion of income

spent on discretionary items.

5. The necessary adjustment in income to immunize

the workers from the effects of componentsinflation.

This is measured by the Compensating Variation.


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Presentation Outline

1. Recent Inflation Developments

2. The Working Class in Lesotho

3. The Representative Worker

4. Analytical Framework

5. Input Data

6. Results

7. Conclusion


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In the OECD countries Food inflation hastracked Headline inflation between 2.4 3.7%

between 2001 and 2005.

From 2006 Food inflation has jumped above

Headline and rising at a faster rate and

diverging further away from Headline inflation.

Energy inflation in the OECD countries has

been above Headline inflation by an average of

6 percentage points between 2001 and 2008.

Recent Inflation Developments


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Recent Inflation Developments (cont.)

In South Africa:Food prices at factory gate jumped up by

an average 18 % in 2008, compared to 13.8 %

in 2007.

Petrol and food price increases accounted

for more than a half of the increase in CPIX

inflation, which was measured at 10.4

percent in April 2008


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Recent Inflation Developments (cont.)

The drivers of these developments include:

Global increased demand for major

commodities

E.g.s of continental growth SSA 6%, Asia 9%

E.g. Over 50% of the increase in demand for oil wasaccounted for by India, China & Mid-East

Biofuels Demand for grains needed for ethanol

production

Credit crunch-induced commodity bubble of2008


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Working Class in Lesotho

Formally employed labor force in Lesotho - 2006Formal Employment by Sector # Employed Percentage

Basotho mine workers 51,341 30.2

Textile and clothing 40,044 23.6

Government 38,144 22.4

Tourism 22,500 13.2

Construction 6,000 3.5

Wholesale, retail & services 12,000 7.1

TotalTotal 170,000170,000 100100


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The Representative Worker

By representative we mean average and the

defining characteristic is income.

First we recognize that it is difficult to get a truly

representative worker given income disparities.

Constructed the following representative

workers:

Low income

Lower -Middle Income

Higher-Middle Income

High Income


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The Representative Worker(cont.)

Table 2: Gross Monthly Income of Respective Representative Workers

Income Classification Gross Monthly

Band

GoL Civil

Servants in the

Band

Representative

Gross Monthly

Income

Low Income M660 M2,999 8,644 (54.3%) M1,569.34

Lower-Middle Income M3,000 M7,999 5,734 (36.1%) M5,033.40

Higher-Middle Income M8,000 M15,999 1,423 (9%) M10,048.00

High Income M16,000 + 93 (0.6%) M18,846.16

Source: Authors computations for GoL civil service payroll data of September 2008


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1 11

1

max where 0 and 1

subject to

i

n

n n

i ix x

ii

n

i i

i

x

p x m

K

Analytical Framework

Representative workers problem is:


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Analytical Framework(cont.)Resulting (Marshallian) demand

functions is:

Rearranging it show that is theproportion of the workers income thatgoes to commodity i:

*

i i

i

mx

p

*i i

i

p x

m


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Analytical Framework(cont.)Welfare is measured by the following IndirectUtility Function:

Analysis is confined to three commoditybaskets Food, Energyand Compositebaskets. Therefore:

1

( , )

in

i

i i

w V m mp

p

CF E

CF E

F E C

w m p p p


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Analytical Framework(cont.)

Income adjustment required (measuredby CV):

Impact of inflation on Workers

Standard of Living:

100

,

1 1 iC ii F E

n

1

E Fn n

E F

o o

E F

p pCV m

p p


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Input Data

To implement the two formulas above thefollowing variables and parameters are needed

as inputs:

1. Disposable income

2. Workers allocation of disposable income torespective baskets

3. Reported inflation of respective baskets and the

resulting price ratios.

Table 3 contains data inputs on 1. and 2. while

Table 4 contains data inputs on 3.


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Input Data (cont.)

Table 3: Representative Worker Expenditure Allocations and Disposable

Income

Alpha F Alpha E Alpha C M08:1 M08:2-4

Low Income 0.510 0.156 0.334 1,426.67 1,569.34Lower-Middle Income 0.443 0.131 0.426 3,558.16 4,051.64

Higher-Middle Income 0.346 0.119 0.535 6,521.33 7,311.13

High Income 0.206 0.120 0.674 11,720.24 13,029.93

Source: Authors inferences and computations


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InputData (cont.)

Table 4: Quarterly Food and Energy Inflation and Corresponding

Price Ratios

FoodInflation

EnergyInflation

Food PriceRatio

EnergyPrice Ratio

2008:1 1.723 0.986 1.0172 1.0099

2008:2 3.606 8.664 1.0361 1.0866

2008:3 6.092 7.859 1.0609 1.0786

2008:4 2.221 -1.234 1.0222 0.9877Source: Authors computations


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Results

Table 5: Change in Representative Workers Standard of Living

Low

Lower-

Middle

Higher-

Middle High

2008:1 -0.010 -0.009 -0.007 -0.005

2008:2 -0.032 -0.028 -0.023 -0.018

2008:3 -0.046 -0.040 -0.032 -0.024

2008:4 -0.010 -0.009 -0.007 -0.003

Total -0.099 -0.085 -0.070 -0.050

Source: Computations by the authors


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Results (cont.)

Across income groups, it can be seen that thesecond and third quarters of 2008 were the most

difficult, with the third quarter inflation being more

severe.

The first and fourth quarter inflation had similarimpact across all groups except the high income

group. The fourth quarter inflation impact was milder

for this group.

Over the entire course of 2008, the low incomesuffered most with their std of living declining by

almost 10% while the high income group suffered

least with their std of living declining by only 5%.


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ResultsResults (cont.)

Table 6: Compensating Variation against Food and

Energy Price Changes of 2008

Low

Lower-

Middle

Higher-

Middle High2008:1 14.93 32.16 47.07 56.03

2008:2 53.09 117.07 175.87 245.07

2008:3 76.66 169.68 249.35 321.41

2008:4 16.63 37.53 51.06 44.78

Total 161.31 356.44 523.35 667.29

% Increase 10.28 8.80 7.16 5.12

Source: Computations by the authors


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Results (cont.)

Once again, across income groups, it can be seen

that the second and third quarters of 2008 were themost difficult, with the third quarter inflation being

more severe in terms of the required income

adjustment.

Over the entire course of 2008, the low incomeshould have secured a 10.28% increase in disposable

income in order to cope with food and energy price

increases.

The high income group should have scored a 5.12%raise just to cope.

Makes loads of sense, doesnt it?


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Summary Results

Low

Lower-

Middle

Higher-

Middle High

% Loss in Stdof Living 9.9 8.5 7.0 5.0

% Increase in

Net Income 10.28 8.80 7.16 5.12


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Conclusion

Inflation hits low income earners more severely than

high income earners and corresponding incomeadjustments should take cognizance of this.

As long as (net) income growth is slower than inflation,

workers standard of living is bound to decline.

The reported required increases in disposable income

are for food & energy price increases only.

Would have probably been higher had inflation on allother goods in the composite basket been taken into

account.

welfare effects of inflation

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