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General Price Level This is the average of current prices across the entire spectrum of goods and services

produced in the economy. The price level is usually examined through a "basket of goods" approach, in which a collection of consumer-based goods and services are examined in aggregate; changes in the aggregate price over time will push the index measuring the basket of goods higher. Weighted averages are typically used rather than geometric means. Price indices that measure the changes of general price level in Sri Lanka are,

Colombo consumer price index Greater Colombo price index Whole sale price index Deflator of gross domestic product

Colombo consumer price index Colombo Consumers' Price Index - from January 1956 onwards: index numbers on base 1952=100 with the following percentage weights for the basket of goods, Food - 61.9 Clothing - 9.4 Fuel & light - 4.3 Rent - 5.7 Miscellaneous - 18.7 Greater Colombo price index The Greater Colombo Consumers' Price Index has a base January to June 1989 = 100 with the following percentage weights:

Food & Drink 69.3; Liquor, Tobacco & Betel and Areca nut 3.8; Housing 8.9; Fuel & Light 5.4; Clothing & Footwear 2.8; Personal Care and Health Services, Household goods & Services 4.9; Transport & Communication 2.8; Miscellaneous 2.1. Weights are based on the Labour Force and the Socio Economic Survey 1985/86 revalued at January - June 1989 prices. Whole sale price index The Wholesale Price Index has a base 2005 = 100. Wholesale price index refers to a mix of agricultural and industrial goods at various stages of production and distribution, including import duties. Deflator of gross domestic product An economic metric that accounts for inflation by converting output measured at current prices into constant-dollar GDP. The GDP deflator shows how much a change in the base year's GDP relies upon changes in the price level. This is also known as the "GDP implicit price deflator".

Inflation Inflation is the name given to an increase in the general price level. it is also refers to the decline in the purchasing power of money. Causes of Inflation 1. Demand-Pull Inflation

Inflation occurs when the aggregate demand rises and exceeds the aggregate supply at the current price level. When an economy is operating at full employment, an increase in aggregate demand will inevitably lead to inflation. Even though there is unemployment in the economy, if the aggregate demand increases faster than the output inflation might occur. Too much money may chase too few goods.

The demand increases in the following situations, (a) The percentage increase in the money supply is higher than the percentage increase in output. (b) Government borrowing from the banking system to finance budget deficits. (c) Credit expansion by the banks.
(d) A sudden rise in export earning of foreign exchange earnings. (e) Inflation expectations.-Expectation of a further rise in the price level will increase the

present demand. 2. Cost-Push Inflation An increase in the costs of production will reduce the supply and cause a rise in the price level. (a) A rise in the prices of raw materials supplied by domestic sources. (b) Rising prices of inputs in foreign markets (higher oil prices).

(c) Depreciation of the currency which raises the prices of imported inputs. (d) Higher wages resulting from trade union activity.

3. Profit-Push Inflation In markets where monopoly power exists (monopoly and oligopoly) firms are able to raise the prices of their products in order to increase their profits. This is another supply side factor that causes inflation 4. Structural Inflation There are structural rigidities in the economies of less developed countries which make the supply inelastic. An increase in demand will not be matched by an increase in output. The price level rises even though there are unutilized resources. Other Types of inflation 1. Creeping Inflation This refers to mild inflation with an annual rate of about 5% or less. 2. Galloping Inflation and Hyper Inflation The inflation rate may rise to 3 digits or more. Hyper inflation causes a loss of confidence in the monetary system.
3. Wage-Price Spiral

Rising price level which increases the cost of living encourages the workers to demand higher wages through their trade unions. Higher wages raise the costs of production and lead to a further rise in the price level.
4. Anticipated (foreseen) inflation and Unanticipated (unforeseen) inflation

The effects of a foreseen inflation are not so serious as those of unforeseen inflation. Wage and price agreements can take account of the expected rise in prices. Most of the adverse effects of inflation occur when inflation is unexpected.

Disinflation and Deflation Disinflation

This is a slowing in the rate of inflation. Disinflation is used to describe instances when the inflation rate has reduced marginally over the short term Deflation

This is a general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression.

Effects of inflation Inflation affects individuals, firms, the government and the economy.
1. Fixed income earners will suffer a loss of real income due to the fall in the purchasing

power of money. Furthermore the real value of their savings will decline. It will cause a reduction in their standard of living.

2. Debtors gain and creditors lose. If the inflation rate exceeds the nominal interest rate, the

real interest rate will be negative. Inflation discourages saving.


3. Inflation creates an uncertainty about the future. Firms will be uncertain about the

prospective real return on investment. This might lower the level of investment and reduce the productive capacity of the economy.
4. The redistributive effects of inflation increase disparities in income and wealth.

5. Effects on foreign trade inflation reduce the competitiveness of export. It makes imports relatively cheap. As a result there would be a fall in export earnings and an increase in the balance of payment deficit.
6. The government might have to face problems of budgeting and planning due to inflation