PRICE HIKE IN INDIA

Inflation means a persistent rise in the general price levels for commodities
and services and subsequently currency’s purchasing power is falling.

“You are all aware that two important external factors have been responsible
for higher inflation. First, rising food and commodity prices around the world and
second, rising world oil prices,”.

There are three major types of inflation, Robert J. Gordon calls the "triangle
model"

• Demand-pull inflation is caused by increases in aggregate demand due to

increased private and government spending, etc. Demand inflation is
constructive to a faster rate of economic growth since the excess demand
and favourable market conditions will stimulate investment and expansion.
If there is demand, the price will rise creating inflation.
Demand is also good for economy..It clears old stocks and the blocked
money is again starts pouring in to the system back.
• 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.
Producers for whom oil is a part of their costs could then pass this on to
consumers in the form of increased prices.
• Built-in inflation is induced by adaptive expectations, and is often linked to
the "price/wage spiral". It involves workers trying to keep their wages up
with prices (above the rate of inflation), and firms passing these higher labor
costs on to their customers as higher prices, leading to a 'vicious circle'.
Built-in inflation reflects events in the past, and so might be seen as
hangover inflation.
Demand side factors:

1) Increase in nominal money supply: Increase in nominal money supply

without corresponding increase in output increases the aggregate demand.
The higher the money supply the higher will be the inflation. When the
government of a country print money in excess, prices increase to keep up
with the increase in currency, leading to inflation.

2) Increase in disposable income: When the disposable income of the people

increases, their demand for goods and services also increases.

3) Expansion of Credit: When there's expansion in credit beyond the safe

limits, it creates increase in money supply, which causes the increased
demand for goods and services in the economy. This phenomenon is also
known as 'credit-induced inflation'.

4) Deficit Financing Policy: Deficit financing raises aggregate demand in

relation to the aggregate supply. This phenomenon is known as 'deficit
financing-induced inflation'.

5) Black money spending: People having black money spend money lavishly,
which increases the demand un-necessarily, while supply remains
unchanged and prices go up.

6) Repayment of Public Debts: When government repays the internal debts it

increases the money supply which pushes the aggregate demand. When
countries borrow money, they have to cope with the interest burden. This
interest burden results in inflation.

7) Expansion of the Private Sector: Private sector comes with huge capitals
and creates employment opportunities, resulting in increased income which
furthers the increase in demand for goods and services.

8) Increasing Public Expenditures: Non developmental expenditures of

government lead to raise aggregate demand which results as increased
demand for factors of production and then increased prices.
9) Credit purchase: Due to increase in credit cards people can puchase in
credit which in result increase demand

10) Speculation: Speculation is also increase demand especially gold and

shares.

11) High Taxes: High taxes on consumer products, can also lead to inflation.

Supply side factors

1) Shortage of factors of production or inputs: Shortage of factors of

production, i.e. raw material, labour capital etc causes the reduced
production, which causes the increase in prices.

2) Industrial Disputes: When industrial disputes come to happen, i.e. trade

unions resort strikes or employers decide lock outs etc the industrial
production reduces. And as a short supply of goods in the market the prices
go up.

3) Natural Calamities: Natural disasters, invasions, diseases etc effect the

agricultural production, and shortage of supply which furthers the rise in
prices.

4) Artificial Scarcities: Hoarders, black marketers and speculators etc create

artificial shortage to earn more profits by keeping the prices high. (in
Pakistan bird flu dilemma and sugar crises are the major examples in this
regard)

5) Increase in exports (excess exports): When the country has tends to earn
maximum foreign exchange and exports more and more without considering
the domestic use of the commodities, it creates a shortage of commodities at
home which increases the prices. (With reference to Pakistan, the failure of
 export bonus scheme during 1950's is the most common example of this type
of cause of inflation)

6) Global factors: This factor includes the changing global environment. Most
common example is the rise in oil prices. This factor of inflation may vary in
nature, i.e. it can be political, strategic, economic or logistic in nature.

7) Neglecting the production of consumer goods: When the production of

consumer goods is neglected with reference to the increased production of
luxuries, it also creates inflation. For example in Pakistan, in last couple of
years our services sector has grown with the highest rate of 8.8% (mainly
telecom sector), while basic necessities have been ignored which created
increase in the prices of consumer goods.

8) Application of law of diminishing returns: this law applies when the

industries use old machines and methods and, which increase in cost by
increasing the scale of production. This furthers the increase in prices and
hence inflation bursts out.

9) Iefficient supply chain: Due to iefficient supply chain supply affects and
cause demand on other side.

Controlling inflation

A variety of methods have been used in attempts to control inflation.

Monetary policy

Today the primary tool for controlling inflation is monetary policy. Most
central banks are tasked with keeping the federal 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.

Fixed exchange rates

Under a fixed exchange rate currency regime, a country's currency is tied in
value to another single currency or to a basket of other currencies (or sometimes to
another measure of value, such as gold). A fixed exchange rate is usually used to
stabilize the value of a currency, vis-a-vis the currency it is pegged to. It can also
be used as a means to control inflation. However, as the value of the reference
currency rises and falls, so does the currency pegged to it. This essentially means
that the inflation rate in the fixed exchange rate country is determined by the
inflation rate of the country the currency is pegged to. In addition, a fixed
exchange rate prevents a government from using domestic monetary policy in
order to achieve macroeconomic stability.

Wage and price controls

In general wage and price controls are regarded as a temporary and

exceptional measure, only effective when coupled with policies designed to reduce
the underlying causes of inflation during the wage and price control regime, for
example, winning the war being fought. They often have perverse effects, due to
the distorted signals they send to the market. Artificially low prices often cause
rationing and shortages and discourage future investment, resulting in yet further
shortages. The usual economic analysis is that any product or service that is under-
priced is overconsumed. For example, if the official price of bread is too low, there
will be too little bread at official prices, and too little investment in bread making
by the market to satisfy future needs, thereby exacerbating the problem in the long
term.

Cost-of-living allowance
The real purchasing-power of fixed payments is eroded by inflation unless
they are inflation-adjusted to keep their real values constant. In many countries,
employment contracts, pension benefits, and government entitlements (such as
social security) are tied to a cost-of-living index, typically to the consumer price
index. A cost-of-living allowance (COLA) adjusts salaries based on changes in a
cost-of-living index. Salaries are typically adjusted annually in low inflation
economies. During hyperinflation they are adjusted more often. They may also be
tied to a cost-of-living index that varies by geographic location if the employee
moves.

The problems due to inflation would be:

• When the balance between supply and demand goes out of control,
consumers could change their buying habits, forcing manufacturers to cut down
production.
• Inflation can create major problems in the economy. Price increase can
worsen the poverty affecting low income household,
• The producers would not be able to control the cost of raw material and
labor and hence the price of the final product. This could result in less profit or in
some extreme case no profit, forcing them out of business.
• Manufacturers would not have an incentive to invest in new equipment and
new technology.
• Uncertainty would force people to withdraw money from the bank and
convert it into product with long lasting value like gold, artifacts.