1. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
Introduction to Basic Economic Theory and Concepts
The Banking Economic Systems
Pricing and Price Mechanism
Inflation
The Government and Economy
Types of Business Organizations
MODULE COVERAGE
1
International Trade and Regional Groupings

2. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
Definition of inflation
• Inflation is the rate at which the general level of prices for goods
and services in an economy rises over a period of time and
subsequently, purchasing power falls. The overall general upward
price movement of goods and services in an economy (often caused
by an increase in the supply of money), usually as measured by the
Consumer Price Index and the Producer Price Index.
• Inflation also reflects erosion in the purchasing power of money – a
loss of real value in the internal medium of exchange and unit of
account in the economy. When the general price level rises, each
unit of currency buys fewer goods and services.
• Most frequently, the term "inflation" refers to a rise in a broad price
index representing the overall price level for goods and services in
the economy. The Consumer Price Index (CPI), the Personal
Consumption Expenditures Price Index (PCEPI) and the GDP deflator
are some examples of broad price indices.
2

3. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
Measures of Inflation
i) Price indices or “Price indexes”
A price index is a normalized average / a weighted average of prices for a given class of
goods or services in a given region, during a given interval of time. It is a statistic
designed to help to compare how these prices, taken as a whole, differ between
time periods or geographical locations.
Price indices have several potential uses. For particularly broad indices, the index can
be said to measure the economy's price level or a cost of living. More narrow price
indices can help producers with business plans and pricing. Sometimes, they can
be useful in helping to guide investment.
Notable price indices include:
• Consumer price index
• Producer price index
• GDP deflator
• Commodity price index
• Core price index
A consumer price index (CPI) measures changes in the price level of consumer goods
and services purchased by households. The CPI is a statistical estimate constructed
using the prices of a sample of representative items whose prices are collected
periodically.
3

4. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
To find the CPI, sub-indexes and sub-sub-indexes are computed for different categories
and sub-categories of goods and services, being combined to produce the overall
index with weights reflecting their shares in the total of the consumer
expenditures covered by the index. It is one of several price indices calculated by
most national statistical agencies.
The annual percentage change in a CPI is used as a measure of inflation. A CPI can be
used to index (i.e., adjust for the effect of inflation) the real value of wages,
salaries, pensions, for regulating prices and for deflating monetary magnitudes to
show changes in real values.
Inflation is usually estimated by calculating the inflation rate of a price index, usually
the Consumer Price Index. The Consumer Price Index measures prices of a
selection of goods and services purchased by a "typical consumer". The inflation
rate is the percentage rate of change of a price index over time.
Assuming the Consumer Price Index for Uganda in January 2007 quoted in dollars at
202.416, and in January 2008 it was 211.080. The formula for calculating the
annual percentage rate inflation in the CPI over the course of 2007 is
4

5. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
ii) The GDP deflator
• This is a measure of the level of prices of all new, domestically produced,
final goods and services in an economy. GDP stands for gross domestic
product, the total value of all final goods and services produced within
that economy during a specified period.
• Commodity price indices - These measure the price of a selection of
commodities. In the present commodity price indices are weighted by the
relative importance of the components to the "all in" cost of an employee.
• Core price indices - Generally, food and oil prices can change quickly due
to changes in supply and demand conditions in the food and oil markets, it
can be difficult to detect the long run trend in price levels when those
prices are included. Therefore most statistical agencies also report a
measure of 'core inflation', which removes the most volatile components
(such as food and oil) from a broad price index like the CPI.
• Because core inflation is less affected by short run supply and demand
conditions in specific markets, central banks rely on it to better measure
the inflationary impact of current monetary policy.
5

6. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
ii) Other economic concepts related
to inflation include:
• deflation – a fall in the general
price level;
• disinflation – a decrease in the
rate of inflation;
• hyperinflation – an out-of-control
inflationary spiral;
• stagflation – a combination of
inflation, slow economic growth
and high unemployment;
• Reflation – an attempt to raise
the general level of prices to
counteract deflationary
pressures.
6

7. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
Causes of inflation:
• Cost Push Inflation
Cost-push inflation, that is, a rise in cost of production, such as, raw materials, causes
prices to rise. Since costs of production have risen, producers pass this burden on
consumers, by charging higher prices.
Higher indirect taxes imposed by the government – for example a rise in the rate of
excise duty on alcohol and cigarettes, an increase in fuel duties or perhaps a rise in
the standard rate of Value Added Tax or an extension to the range of products to
which VAT is applied. These taxes are levied on producers (suppliers) who,
depending on the price elasticity of demand and supply for their products, can opt
to pass on the burden of the tax onto consumers
• Demand pull inflation
Caused by an increase in aggregate demand in this case, demand for all products rise,
causing the demand curve to shift upwards, hence increasing the general price
level.
• Imported inflation
This is when a country is importing materials from another country, in which inflation
is high.
7

8. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
• Increase of money supply in an economy.
It is a situation of too much money chasing too few goods, hence increasing the price
of goods. This could be due to an increase in demand due to increase in
government and private spending; decrease in supply due to increase in input
prices or increase in wages of workers resulting in higher prices by the employers.
Common factors that cause a rise or fall in the price of goods and services are:
a) a change in the value or production costs of the good,
b) a change in the price of money which then was usually a fluctuation in the
commodity price of the metallic content in the currency,
c) Currency depreciation resulting from an increased supply of currency relative to
the other currencies.
• Currency Depreciation is the decrease in the value of a currency with respect to
other currencies. This means that the depreciated currency is worth fewer units of
some other currency. While depreciation means a reduction in value, it can be
advantageous as it makes exports in the depreciated currency less expensive. For
example, suppose one unit of Currency A is worth one unit of Currency B. If
Currency A depreciates such that it becomes worth half of one unite of Currency B,
then exports denominated in Currency A are only half as expensive when trading
in a Currency B market.
8

9. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
Effects of Inflation an economy
These can be positive and negative. Negative effects of inflation include a decrease in
the real value of money and other monetary items over time, uncertainty over
future inflation may discourage investment and savings, and high inflation may
lead to shortages of goods if consumers begin hoarding out of concern that prices
will increase in the future.
Positive effects include ensuring central banks can adjust nominal interest rates
(intended to mitigate recessions), and encouraging investment in non-monetary
capital projects.
Economists generally agree that high rates of inflation and hyperinflation are caused
by an excessive growth of the money supply. Views on which factors determine
low to moderate rates of inflation are more varied. Low or moderate inflation may
be attributed to fluctuations in real demand for goods and services, or changes in
available supplies such as during scarcities, as well as to growth in the money
supply. However, the consensus view is that a long sustained period of inflation is
caused by money supply growing faster than the rate of economic growth.
Today, most mainstream 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.
9

10. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
Controlling Inflation:
• Monetary policy
This is the primary tool for controlling inflation. Most central banks are tasked with
keeping their funds lending rate at a low level; normally to a target rate around 2%
to 3% per annum, and within a targeted low inflation range, somewhere from
about 2% to 6% per annum.
A low positive inflation is usually targeted, as deflationary conditions are seen as
dangerous for the health of the economy.
High interest rates and slow growth of the money supply are the traditional ways
through which central banks fight or prevent inflation, though they have different
approaches.
Monetarists emphasize keeping the growth rate of money steady, and using monetary
policy to control inflation (increasing interest rates, slowing the rise in the money
supply).
Keynesians emphasize reducing aggregate demand during economic expansions and
increasing demand during recessions to keep inflation stable. Control of aggregate
demand can be achieved using both monetary policy and fiscal policy (increased
taxation or reduced government spending to reduce demand).
10

11. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
Examples of monetary policies to control inflation are:
1. Central Bank selling high yielding Treasury Bills to “mop-up liquidity”
2. Increase in the base lending rates by the Central bank, which causes
commercial banks to also raise their lending rates, thus lowering
borrowing and overall money supply in the economy
3. Raising reserve requirements of commercial banks at the Central bank
• Fiscal policy
These fiscal policies reduce injections into the circular flow of income and will
reduce demand pull inflation at the cost of slower growth and
unemployment. Examples of fiscal policies to control inflation are:
1. Higher direct taxes (causing a fall in disposable income)
2. Lower Government spending
3. A reduction in the amount the government borrows each year
11