of 25
8/14/2019 Welfare Effects of Inflation
1/25
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
8/14/2019 Welfare Effects of Inflation
2/25
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
8/14/2019 Welfare Effects of Inflation
3/25
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.
8/14/2019 Welfare Effects of Inflation
4/25
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
8/14/2019 Welfare Effects of Inflation
5/25
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
8/14/2019 Welfare Effects of Inflation
6/25
8/14/2019 Welfare Effects of Inflation
7/25
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
8/14/2019 Welfare Effects of Inflation
8/25
8/14/2019 Welfare Effects of Inflation
9/25
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
8/14/2019 Welfare Effects of Inflation
10/25
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
8/14/2019 Welfare Effects of Inflation
11/25
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
8/14/2019 Welfare Effects of Inflation
12/25
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
8/14/2019 Welfare Effects of Inflation
13/25
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:
8/14/2019 Welfare Effects of Inflation
14/25
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
8/14/2019 Welfare Effects of Inflation
15/25
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
8/14/2019 Welfare Effects of Inflation
16/25
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
8/14/2019 Welfare Effects of Inflation
17/25
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.
8/14/2019 Welfare Effects of Inflation
18/25
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
8/14/2019 Welfare Effects of Inflation
19/25
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
8/14/2019 Welfare Effects of Inflation
20/25
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
8/14/2019 Welfare Effects of Inflation
21/25
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%.
8/14/2019 Welfare Effects of Inflation
22/25
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
8/14/2019 Welfare Effects of Inflation
23/25
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?
8/14/2019 Welfare Effects of Inflation
24/25
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
8/14/2019 Welfare Effects of Inflation
25/25
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.