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Chap III Inflation

Inflation refers to a sustained increase in price levels that leads to a decrease in purchasing power. It occurs when there is too much money chasing too few goods. Inflation can be mild, creeping, or hyper (extremely rapid). The main causes are demand-pull factors like increased money supply, and cost-push factors like higher wages and import prices. Inflation hurts fixed-income groups, workers, and creditors while benefiting producers and debtors initially. Governments use monetary, fiscal, and other policies to control inflation. Deflation is the opposite of inflation with falling prices and reduced purchasing power.

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41 views34 pages

Chap III Inflation

Inflation refers to a sustained increase in price levels that leads to a decrease in purchasing power. It occurs when there is too much money chasing too few goods. Inflation can be mild, creeping, or hyper (extremely rapid). The main causes are demand-pull factors like increased money supply, and cost-push factors like higher wages and import prices. Inflation hurts fixed-income groups, workers, and creditors while benefiting producers and debtors initially. Governments use monetary, fiscal, and other policies to control inflation. Deflation is the opposite of inflation with falling prices and reduced purchasing power.

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VAISALY S MBA
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Inflation

Inflation
• A sustained rise in the prices of
commodities that leads to a fall in the
purchasing power of a nation is called
inflation.

– Rise in Price of commodity leads to --------


– Fall in purchasing power of a nation
Definitions
• “too much money chasing too few goods”
» Coulborn

• “a state in which the value of money is falling and


the prices are rising”
» Crowther

• “abnormal increase in the quantity of purchasing


power”
» T.E Gregory
What is Inflation?

• High prices should not be considered as


inflation

• Only persistent increase in prices to


abnormal extent is called inflation.
Stagflation
• High inflation and high unemployment
(stagnation) occurring simultaneously.

• A condition of slow economic growth and


relatively high unemployment - a time of
stagnation - accompanied by a rise in prices, or
inflation.

• Inflation along with stagnation of GNP is called


Stagflation
Characteristics of Inflation
• Persistent rise in prices

• Excessive supply of money in the economy

• Vicious circle of inflationary spiral created


by the velocity of the money
Quantifying inflation
• To quantify the amount of inflation the
following indicators are used
wholesale price index
retail price index
GDP Deflators
Inflation rate –India
The inflation rate in India was recorded at 6.46 percent in September of
2014. Inflation Rate in India averaged 9.35 Percent from 2012 until 2014,
reaching an all time high of 11.16 Percent in November of 2013 and a
record low of 6.46 Percent in September of 2014.

Inflation Rate in India is reported by the Ministry of Statistics and


Programme Implementation (MOSPI), India.
Rate of inflation
• Rate of Inflation (t)

Pt - Pt -1
t= ------------- * 100
P t-1
Pt – price level in the year t, p t-1 – price level in the year t-1 (base year)
If there is a decline in the rate of inflation is
called disinflation.
Types Of Inflation
• Classification based on control
– Open inflation – free market economy
– Suppressed inflation – controlled economy
• Basis of severity
– Creeping inflation
– Galloping inflation
– Hyper inflation
• Sectoral Demand Shift Inflation
Degrees of Inflation

• Mild Inflation

• Creeping inflation

• Galloping Inflation (or) Hyper Inflation


Mild Inflation
• It is associated with mild rising price

• It is a situation in which there is a sustained, non-excessive,


and general increase in prices.

• The increase in prices must smallest amount for a reasonable


period of time.

• If prices go up during this period and fall in the next, then it


is mere price fluctuation.

• Since it is mild it is not much of consideration


Creeping Inflation
• Inflation at moderate rates but continues over long periods.

• This is the normal state of affairs in many countries.

• A sustained inflation of 2% per year will cause prices to


increase over fivefold in a century.

• Slow but unstoppable continuing Inflation that, though it


seems tolerable in the short run, nonetheless leads to
significant long-run price increases.

• The creeping inflation if unchecked will result in the


galloping inflation
Hyperinflation
• Extremely rapid or out of control inflation. 

• There is no precise numerical definition to hyperinflation.

• Hyperinflation is a situation where the price increases are


so out of control that the concept of inflation is
meaningless

• If hyperinflation often occurs when there is a loss of


confidence in a currency's ability to maintain its value in
the consequences.
Hyperinflation
• One of the most famous examples of
hyperinflation occurred in Germany between
January 1922 and November 1923.

• By some estimates, the average price level


increased by a factor of 20 billion, doubling every
28 hours.
Sectoral Demand Shift Inflation
In a dynamic economy there is a continuous shift
in demand from one sector to another.
Such shifts raise the wages and prices in those
sectors towards which demand shifts but do not
lead to wage and price reductions in the sectors
from which demand shifts away.
Types of inflation
Basis of causes-(Causes of Inflation)

Inflation

Cost-Push Demand-Pull Imported


Inflation Inflation Inflation
Demand-Pull Inflation
• A term used in Keynesian economics to describe the
scenario that occurs when price levels rise because of an
imbalance in the aggregate supply and demand. 

• When the aggregate demand in an economy


strongly outweighs the aggregate supply, prices increase.

• Economists will often say that demand-pull inflation is a


result of too many rupees chasing too few goods.
Demand-Pull Inflation
• This type of inflation is a result of strong
consumer demand.

• When many individuals are trying to purchase the


same good, the price will inevitably increase.

• When this happens across the entire economy for


all goods, it is known as demand-pull inflation.
Factors on demand side
• Money supply
• Disposable income and consumer
expenditure
• Business outlay and
• foreign demand
Cost-Push Inflation

• A phenomenon in which the general price levels


rise (inflation) due to increases in the cost of wages
and raw materials.

• Cost-push inflation develops because the higher


costs of production factors decreases in aggregate
supply (the amount of total production) in the
economy. 
Factors on cost side
• Wage push pressure
• Profit push and markup pricing
• Import Prices
• Exchange rates
Imported Inflation

• Higher import prices or higher export


prices or both can generate inflation in the
economy.

• Imports creates inflation through


International trade multiplier
Effects of Inflation

• On Producers

• Prosperity for the producing classes

• They will get windfall profit & appreciation in


the value of their stock

• Blessing to the producers at the initial stage


Effects of Inflation

• On Working Class

• They will suffer due to rising prices

• “Prices go up by lift, while wages go up by steps”

• Low purchasing power


Effects of Inflation
• On Fixed Income Groups

• The worst hit class during inflation

• People will live on their past savings and investments

• Aggregate consumption will decline


Effects of Inflation
• On Debtors and Creditors

• The debtors (borrowers gain much

• Creditors (lenders) lose heavily due to the real value


of the money
Effects of Inflation
• On Distribution

• Will have bad effects on distribution

• Inequality between rich and poor will be increased

• Some class of people enjoy the benefits of inflation


and some other will be suffering
Effects of Inflation
• On Government
• The government too will be affected
• The public sector’s expenditure level will rise
• Cut the size of the public welfare programme

• Benefits to the Government


– The burden of the public debt will be reduced
since the government is the largest borrower
of public debt.
Control of inflation
• Monetary policy
• Fiscal policy
• Wage control
• Price control
• Indexation
Deflation
It is the opposite of inflation
It is a state of disequilibirium in which a
contraction of purchasing power tends to
cause a decline of the price level.
Features
falling price, reduced money
supply and unemployment.

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