When the Government Prints Money- A Case Study of Tap Island
The research is based on Tap Island with a population of 6000people and produces a total of 6000bags of corn that every citizen can afford to buy just one bag per year due to the limited resources available despite their deep love for corn. The Tap Island government prints more money and lets it circulate in the economy such that every citizen has twice the money that he/she initially had. Here is a detailed insight on what would happen to the economy of Tap Island.
Why Would The Government Print More Money?
The government would print more to settle an overdraft in its budget that is when the estimated budget is more than what the government has and can accumulate within that financial year. It would want to settle a subsidiary budget that arose as an outcome that was not budgeted and requires government spending such when a national disaster occurs like the attack of corn by locusts to guarantee food security for the citizens.
To encourage innovation to increase production of goods and services as the market is already available and appealing. Also to encourage imports into the country as the market is appealing to the importers.
What Is The Impact Of Printing More Money And Allowing It In Circulation?
A hypothetical approach is taken to get the end result of the measure taken by the Tap Island government. Each citizen has the ability to purchase only one bag of corn per year at 1000 U.S dollars. The government allows more money into the economy and every citizen has an excess of 1000U.S dollars with a constant production of 6000bags.
Assumptions In The Corn Market
The citizens do not have anything else to spend their money on apart from corn, that is, there are no substitutes. There is no individual or business engages in importation of corn either legally or illegally and the production of corn remains constant. Also, the citizens have the same high preference and liking for corn
Expected Outcomes In The Market
There will an increased demand for corn as the resources and the likes and preferences for corn are high. The supply of corn will be low as compared to demand. The suppliers will increase the prices for corn to increased demand.
Assuming that every citizen will be allowed to purchase only 1bag of corn like before and the government does not intervene on the prices, then every citizen will use all the money for the purchase of corn implying that the new prices of corn will be 2000. This hiking of prices is called inflation and in this case the inflation rate will be calculated using the formula:
Inflation= ((new price-initial price)/initial price))*100%
= ((2000-1000)/1000))*100 = (1/1)*100= 100%
This implies that doubling the supply of money to an economy while the output. This remains constant leads double prices and thus an inflation rate of 100%. This type of inflation is called Demand-pull inflation as the demand for the commodity is more than the production capacity of the commodity (Machlup, 1960). The other type of inflation is the cost-push inflation that comes about when the costs for production are high making the producers to increase the prices of the end products. Inflation has the following effects on the economy: Loss of purchasing power where one requires a bulky of money to purchase a small quantity of goods and services and positive impact on debtors as they pay their debts with money that is less valuable.