Prepared By

Dipal Prajapati(15) Vikrant Thakar() Gaurav Vaghela() Nikita Patel() Fouram Shah()

Outlines
y Introduction y Measures of Inflation y Classification of Inflation y Causes of Inflation y Effect of Inflation y Steps Taken by The Government to Control Inflation y Statistical Data of Inflation in India y Deflation y Stagflation

Introduction
y Inflation is a situation where the aggregate demand of

goods and services exceeds the available supply and due to this there is an increase in the price level. y Situation of rapid general increase in price level. y Decline in the value of money. y In inflation everything gets more valuable except money

Money Supply, Money Demand, and the Equilibrium Price Level

Value of Money, 1/P (High) 1 Money supply Price Level, P 1 (Low)

34

1.33

12

2 Equilibrium price level

Equilibrium value of money

14

4 Money demand

(Low)

Quantity fixed by the Fed

Quantity of Money

(High)

Copyright 2004 South-Western

The Effects of Excess Money Supply

Value of Money, 1/P (High) 1 1. An increase in t e money supply . . . A Price Level, P 1 (Low)

MS1

MS2

2. . . . decreases t e value of money . . .

12

14

(Low) 0 M1 M2 Quantity of Money

/4

1. . . . . and increases t e price level.

B Money demand

(High)

Copyright 2004 South-Western

Measures of Inflation
y Consumer Price Index (CPI) y GDP deflator y Wholesale Price Index (WPI) y Producer Price Index (PPI) y Commodity price indices y Core price indices

Measures of Inflation
y Consumer Price Index (CPI) y A measure of the average price of consumer goods and services purchased by households y CPI indicates the change in the purchasing power of the consumer y GDP deflator y Measure of the price of all the goods and services included in Gross Domestic Product (GDP)

Measures of Inflation
y Wholesale Price Index (WPI) y WPI is the price of a representative basket of wholesale goods. y India- the only major country that uses WPI y WPI focuses on the price of goods traded between corporations, rather than goods bought by consumers(measured by the CPI) y The WPI number is a weekly measure of wholesale price movement for the economy y consists of over 2,400 commodities y The indicator tracks the price movement of each commodity individually y Calculation
y y

Relative Method: It is the weighted arithmetic mean based on the fixed valuebased weights for the base period Calculation Method: Monthly price indexes are compiled by calculating the simple arithmetic mean of three ten-day sample prices in the month.

Measures of Inflation
y Producer Price Index (PPI) y Measure the average change over time in selling prices by domestic producers of goods and services. y PPI measures price change from the perspective of the seller. y In India and the United States, an earlier version of the PPI was called the Wholesale Price Index.

Measures of Inflation
y Commodity price indices y Measure the price of a selection of commodities y Core price indices y Because food and oil prices can change quickly due to changes in supply and demand conditions in the food and oil markets, it can be difficult to detect the long run trend in price levels when those prices are included. y Therefore most statistical agencies also report a measure of 'core inflation', which removes the most volatile components (such as food and oil) from a broad price index like the CPI.

Classification of Inflation
y ACCORDING TO THE RATE OF INFLATION y ACCORDING TO THE NATURE OF THE TIME

PERIOD OF OCCOURANCE y ACCORDING TO THE SCOPE AND COVERAGE y ACCORDING TO THE GOVERNMENT REACTION y ACCORDING TO THE CAUSE y ACCORDING TO THE SCHOOL OF THOUGHTS

ACCORDING TO THE RATE OF INFLATION

y Moderate Inflation (Creeping inflation - Walking inflation) y A mild and tolerable form of inflation y Occurs when prices are rising slowly y It does not disrupt the economic balance y Regarded as stable Inflation which appears tolerable in the short run, but leads to important long-run cost increases y 3 per cent annual rate of inflation as creeping inflation and if it exceeds 10 per cent, it is called walking inflation y Running and Galloping Inflation y The movement of price accelerates rapidly y Economists have not described the range of running inflation. But, we may say that a double digit inflation of 10-20 per cent per annum is a running inflation. y If it exceeds that figure, it may be called galloping inflation. y Hyperinflation y The price rise is severe y The most decline in people s purchasing power y The velocity of circulation of money increases very fast y The structure of the relative prices of goods become highly unstable

ACCORDING TO THE NATURE OF THE TIME PERIOD OF OCCOURANCE

y War-Time Inflation y On account of increased government expenditure on defense which is of an unproductive nature. y By such public expenditure, the government allot a large production of goods and services out of total availability for war which causes a downward shift in the supply; as a result, an inflationary gap may develop. y Post-war Inflation y The disposable income of the community increases, when war-time taxation is withdrawn or public debt is repaid in the post-war period y Peace-time Inflation y The rise in prices during the normal period of peace

ACCORDING TO THE SCOPE AND COVERAGE

y Comprehensive Inflation y When prices of every commodity throughout the economy rise, it is called economy-wide or comprehensive inflation. y It is a normal inflationary phenomenon and refers to a rise in the General Price level y Sporadic Inflation y This is a kind of sectional inflation. It consists of cases in which the averages of a group of prices rise because of increases in individual prices due to abnormal shortage of specific goods. y For instance, during drought conditions when there is a failure of crops, food grain prices shoot up.

ACCORDING TO THE GOVERNMENT REACTION

y Open Inflation y When the government does not attempt to prevent a price rise, inflation is said to be open. y Inflation is open when prices rise without any interruption. y The free market mechanism is permitted to fulfill its historic function of rationing the short supply of goods and distribute them according to consumer s ability to pay. y Repressed Inflation y When the government interrupts a price rise, there is a repressed or suppressed inflation y Price increases are prevented at the present time through an adoption of certain measures like price controls and rationing by the government

ACCORDING TO THE CAUSE

y Credit Inflation y Deficit Inflation y Scarcity Inflation y Profit Inflation y Foreign-Trade Induced Inflation y Tax Inflation y Cost Inflation y Demand Inflation

ACCORDING TO THE SCHOOL OF THOUGHTS

y Demand-Pull Inflation y According to the demand-pull theory, prices rise in response to an excess of aggregate demand over existing supply of goods and services. y By an increase in the quantity of money, when the economy is operating at full employment level y Quantity of money - increases, Rate of interest decreases, Investment - increase. y Aggregate consumption expenditure will increase leading to an increase in the demand and inflationary forces may emerge y Cost-Push Inflation y An increase in costs, as factors of production try to increase their share of the total product by raising their prices. y prices are being pushed up by the rising factor costs y It is sometimes induced by the wage inflation process.

Causes of inflation
y Increases in money supply y Expansion of bank credit y Deficit financing y Black money y Scarcity y Taxes y Population growth y Extreme Imbalance of Global Economy y Fuel Price Hike

Effect of Inflation
y The impact of Inflation on the economic system may

be classified into 3 kinds y Effects on production (Changes in the routine of economic activity) y Effects on income distribution (Re-distribution of income and wealth) y Effects on the consumption and welfare

Effects on production
y Inflation has a favorable effect on production when

there are unutilized or under-employed resources in existence in an economy . y Rising prices breed optimistic expectations within the business community, in view of increasing profit margins, if the price level moves up at a faster rate than the cost of production

Effects on Income distribution

y Inflation redistributes income. Prices of all factors do

not rise in the same proportion. Since the effort of inflation on the incomes of different classes of earners varies, there are serious social consequences. y During inflation, the distribution of shares to the profiteers increases more than that of the wage earners or fixed-income earners, such as the retier class. All producers , traders and speculators gain during an inflation because of the windfall profits which arise, because prices rise at a faster and higher rate than the cost of production.

Effects on the consumption and welfare

y Inflation implies an erosion of the consumer s value of

money. It is a form of taxation. Due to deteriorating purchasing power the real consumption of the common people declines. Rising cost of living during inflation implies falling standard of living and lowering of general economic welfare of the community at large . y In short, inflation is unfair on the distribution of side of economic activity.

INFLATION AFFECTING THE COMMON MAN

y Fuel Hike y Food Price Hike y Day to Day Savings y Widening The Gap Between The Rich and The Poor

Steps Taken by The Government to Control Inflation

y The Government said that liberalization of imports, banning

y y y y

exports and a cut in excise and customs duties are among the steps taken by the Government to control inflation in the country. The Government has directed the Reserve Bank of India (RBI) to take monetary measures and to put down interest rates to control Inflation. The central government of india has directed the chief ministers of all the states in india to take preventive measures to control inflation like cutting down of sales tax , custom and excise duties Some of the state Governments have taken up the initiative to provide lower priced ration goods for the Below Poverty Line (BPL) masses. Emphasis On Biofuel

Statistical Data of Inflation in India

Deflation
y A decrease in the general price level of goods and services y Opposite of inflation. y Deflation occurs when the annual inflation rate falls below zero percent (a negative inflation rate) y resulting in an increase in the real value of money allowing one to buy more goods with the same amount y Direct contractions in spending y In the form of a reduction in government spending, personal spending or investment spending. y Deflation has often had the side effect of increasing unemployment in an economy, since the process often leads to a lower level of demand in the economy.

Causes of deflation
y Decreasing money supply. y Increasing supply of goods. y Decreasing demand of goods. y Increasing demand for money.

Stagflation
y Stagflation is the situation when both the inflation

rate and the unemployment rate are persistently high y Causes

y Stagflation can result when the productive capacity of

an economy is reduced by an unfavorable supply shock, such as an increase in the price of oil for an oil importing country. y Stagnation can result from inappropriate macroeconomic policies.