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INFLATION

What is Inflation
# Inflation is a general increase in the overall
price level of the goods and services in the
economy
# Inflation occurs when the prices of goods
and services increase over time. Inflation
cannot be measured by an increase in the
cost of one product or service.
# Inflation occurs due to an imbalance
between demand and supply of money,
changes in production and distribution cost or
increase in taxes on products.

# When economy experiences inflation, i.e.


when the price level of goods and services
rises, the value of currency reduces. This
means now each unit of currency buys fewer
goods and services.

# High prices of day to day goods make it


difficult for consumers to afford even the
basic commodities in life. Hence the
government tries to keep inflation under
control.

# Contrary to its negative effects, a moderate


level of inflation characterizes a good
economy as it encourages people to invest
more and borrow more, because during times
of lower inflation, the level of interest rate
also remains low.
# Hence the government as well as the
central bank always strive to achieve a
limited level of inflation.

What are different types of inflation :

DEMAND - PULL INFLATION:

# Demand inflation occurs when supply


cannot expand any more to meet demand;
that is, when critical production factors are
being fully utilized, also called Demand
inflation.
# Therefore, for anincrease in demand to
cause inflation, there must be a supply
constraint, otherwise supply would simply
rise to meet demand.

COST - PUSH INFLATION:


This type of inflation occurs when general
price levels rise owing to rising input
costs. In general, there are several factors
that could contribute to Cost-Push inflation
such as rising wages, increases in
corporate taxes and imported inflation etc.

BASED ON VALUE OF INFLATION


1. Creeping inflation
If rate of inflation is low (upto 3%)
2. Walking/Trotting inflation
Rate of inflation is moderate (3-7%)
3. Running/Galloping inflation
Rate of inflation is high (>10%)
4. Runaway/Hyper Inflation
Rate of inflation is extreme

CAUSES
1. Increase in money supply
2. Inadequate agricultural and industrial growth
3. Rising import prices
4. Rising taxes
5. Rising house prices
6. Raw material prices
7. Rising wages

IMPACT
Positive Impact

1. Inflation is good for the economy


upto reasonable limits.
2. This according to RBI is 4%
(variation of 2%).
3. Moderate inflation stimulates
growth.
4. A continuous deflation (a fall in
prices negative inflation) is very
harmful.

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Negative Impact
Real income of people would decrease.
Inflation is regressive in nature.
Would increase income inequalities.
Capital
formation
is
adversely
affected.
Promotes generation of Black Money.
Standard of living would reduce.
Promote hoarding and speculation.
Adversely effects BOP situation

Related Terms

1. Inflation: Persistent increase in price


level
2. Disinflation: Reduction in the rate of
inflation
- Price level decreases
- No adverse effect on economy
3. Deflation: Persistent decrease in
price level (negative inflation)
4. Reflation: Price level increases when
economy recovers from recession

1. Stagflation: Inflation + Recession


The highlight of this situation is rising
prices
accompanied
by
rising
unemployment.
2. Misery index:
Rate
of
inflation
+
Rate
of
unemployment
3. Inflationary gap:
Aggregate demand > Aggregate supply

4. Deflationary gap:
Aggregate supply > Aggregate demand
5. Suppressed / Repressed inflation:
Here govt. will not allow rising of prices.
6. Open inflation:
Situation where price level rises without
any price control measures by the
government.