INFLATION : NATURE,EFFECT AND CONTROL

• INFLATION is a rise in the general level of prices
of goods and services in an economy over a
period of time. When the general price level
rises, each unit of currency buys fewer goods
and services.
MEANING OF INFLATION

INTRODUCTION
Inflation is defined as a sustained increase in the
price level or a fall in the value of money.
It is measured as a rate percentage per unit time, say
a year or month.
When the level of currency of a country exceeds the
level of production, inflation occurs.
Value of money depreciates with the occurrence of
inflation.

VARIATIONS ON INFLATION
 Deflation is when the general level of prices is falling. This is the
opposite of inflation.
Hyper inflation is unusually rapid inflation. In extreme cases, this
can lead to the breakdown of a nation's monetary system.
Stagflation is the combination of high unemployment and economic
stagnation with inflation..

RATE OF INFLATION
Rate of inflation is the rate of change of the general
price level. It is measured by simple formula:
Rate of inflation t=Pt-Pt-1 Pt-1
Where, Pt=price level in the year t
Pt-1=price level in the year t-1,the base year
If there is a decline in the rate of inflation such a
situation is called DISINFLATION.

EFFECTS OF INFLATION
Investment
Interest rates
Exchange rates
Unemployment
Stocks
Decrease in the purchasing power
Change the allocation of income

CAUSES OF INFLATION
FACTORS ON DEMAND SIDE:
Increase in money supply
Increase in disposable income
Deficit financing
Foreign exchange reserves
FACTORS ON SUPPLY SIDE
oRise in administered prices
oErratic agriculture growth
oAgricultural price policy
oInadequate industrial growth

CAUSES OF INFLATION
Demand-Pull Inflation
This theory can be summarized as "too much money
chasing too few goods". This usually occurs in growing
economies.
The demand for goods and services increases and
production remains the same or does not increase as fast.
the excess demand results in prices being “pulled up”.
Demand pull inflation occurs when total demand for goods
and services exceeds the total supply.
This type of inflation happens when there is an inflationary
gap

Demand Pull Inflation
P2
P1
Q2Q1
Aggregate Supply
Aggregate Demand 2
Aggregate Demand 1
Price
Real GDP

COST-PUSH INFLATION
 When companies' costs go up, they need to increase prices
to maintain their profit margins.
Caused by an increase in the cost of production. Increased
costs “push up” the price level.
Cost push inflation can result from change in aggregate
supply.
The two main sources of change in aggregate supply are
increase in wage rate and price of raw material.

12
Cost Push Inflation
P2
P1
Q2 Q1
Aggregate Supply 2
Aggregate Demand
Price $
Real GDP ($)
Aggregate Supply 1

HOW TO CONTROL INFLATION
Monetary
Measures
Other
Measures
Fiscal
Measures

MONETARY MEASURES
Credit Control central bank should pursue credit control policy. In order to
control cash reserve ratio etc. it can also issue notice to other banks in
order to control credit.
• Deficit Financing It means printing of new currency notes by Reserve
Bank of India .If more new notes are printed it will increase the supply of
money thereby increasing demand and prices.
Issue of New Currency During Inflation the RBI will issue new currency
notes replacing many old notes. This will reduce the supply of money in the
economy.

Fiscal Measures
Reduction in Unnecessary Expenditure
Increase in Taxes
Increase in Savings
Public Debt
Imposition of new Taxes
Wage Control
Rationing
Maintaining Surplus Budget

OTHER MEASURES
 To Increase Production
 Rational Wage Policy
 Price Control
Increase in Imports of Raw materials
2. Decrease in Exports
4. Provision of Subsidies
5. Use of Latest Technology
6. Rational Industrial Policy

HOW IS IT MEASURED
Consumer Price Index
Wholesale Price Index

CONSUMER PRICE INDEX
 CPI is a measure estimating the average price of consumer
goods and services purchased by households.
CPI measures a price change for a constant market basket of
goods and services from one period to the next within the same
area (city, region, or nation).
It is a price index determined by measuring the price of a
standard group of goods meant to represent the typical market
basket of a typical urban consumer. The percent change in the CPI
is a measure estimating inflation.

WHOLESALE PRICE INDEX
 WPI was published in 1902,and was one of the economic
indicators available to policy makers until it was replaced by
most developed countries by the CPI market. index in the
1970.
 WPI is the index that is used to measure the change in the
average price level of goods traded in wholesale market.
 Some countries (like India and The Philippines) use WPI
changes as a central measure of inflation. However, India and
the United States now report a producer price index instead.

PROBLEMS WITH WPI
In present day service sector plays a key role in Indian economy.
Consumers are spending loads of money on services like education
and health. And these services are not incorpated in calculation of
WPI.
WPI measures general level of price changes either at level of
wholesaler or at the producer and does not take into account the
retail margins.
WPI is supposed to measure impact of prices on business. “But we
use it to measure the impact on consumers. Many commodities not
consumed by consumers get calculated in the index.

INFLATION - KEYNESIAN VIEW
Keynesian economics proposes that changes in money
supply do not directly affect prices, and that visible inflation is
the result of pressures in the economy expressing
themselves in prices.
Demand-pull inflation is caused by increases in aggregate
demand due to increased private and government spending.

 Cost-push inflation, also called "supply shock inflation," is
caused by a drop in aggregate supply (potential output).
 This may be due to natural disasters, or increased prices of
inputs.
 For example, a sudden decrease in the supply of oil,
leading to increased oil prices, can cause cost-push
inflation.

MONETARIST VIEW
Consider fiscal policy, or government spending and
taxation, as ineffective in controlling inflation.
The quantity theory of money, simply stated, says that any
change in the amount of money in a system will change the
price level.
MV = PQ
where
M is the nominal quantity of money.
V is the velocity of money in final expenditures;
P is the general price level;
Q is an index of the real value of final expenditures;

THE PHILLIPS CURVE
Wage growth %
(Inflation)
Unemployment (%)
The Phillips Curve shows an inverse relationship
between inflation and unemployment. It suggested that if
governments wanted to reduce unemployment it had to
accept higher inflation as a trade-off.
Money illusion – wage rates rising but individuals not
factoring in inflation on real wage rates.
1.5%
6%4%
2.5%
PC1

INDIA INFLATION RATE
The inflation rate in India was recorded at 8.59 percent in April of 2014.
Inflation Rate in India averaged 9.67 Percent from 2012 until 2014,
reaching an all time high of 11.16 Percent in November of 2013 and a
record low of 7.55 Percent in January of 2012.
Inflation Rate in India is reported by the Ministry of Commerce and
Industry, India.
The inflation rate in India was last reported at 8.8 percent in February of
2012.
 From 1969 until 2010, the average inflation rate in India was 7.99
percent reaching an historical high of 34.68 percent in September of
1974 and a record low of -11.31 percent in May of 1976.

INFLATION : NATURE,EFFECT AND CONTROL

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INFLATION : NATURE,EFFECT AND CONTROL