INFLATION

Contents

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INFALTION TYPES OF INFLATION EFFECTS OF INFLATION CONCLUSION

INFLATION
Increase in the price of goods and services over a period of time.

Purchase value or money value not increasing.

It reduces the purchasing power of the currency or money.

PHILLIPS CURVE

 If unemployment rate is low, the wage rate increases. But unemployment rate is high, the wage rate will increase more slowly or decrease. Link between wages are changing and prices are changing rate of Inflation is directly related.

 Unemployment rate is positive. Unemployment rate that occurs at full employment, when the economy is producing at potential output Natural rate of unemployment. Relationship between inflation and unemployment is not stable.

 Output

> potential, unemployment falls below natural

rate inflation increases. Output < potential, unemployment rate above natural rate, inflation decreases. Short run inflation adjustment curve.

 As Labour cost increases, the marginal cost also increase which in turn reflect in the final cost of goods or service.

Milton Friedman and his followers this relationship between unemployment and inflation is short run. In long run they can exist and rise together.
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INFLATION RATE

It is the annual percentage change in Inflation

calculated on consumer price index.

Consider Inflation for 2008 is x and for 2009 is y Rate :

y x \ x * 100

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Various rates of Inflation

Creeping rate : Marginal Inflation rate. Ex :- rate increasing from 1 to 3 %.

Double Digit Inflation An inflation rate of 10 % is generally detrimental socially and politically. It can cause serious economic drain.

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Walking Inflation : When other factors get added by other

factors and price rise become more marked.

Running Inflation : If the price rise is become more rapid. Hyper Inflation : If the price rise happens every moment

Ex :- Hyper Inflation begins when prices start rising more than 50%( by Philip Cagan)

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Another Classification
Based on scope

a)

Comprehensive : When price rise increases throughout the economy without any exception.

b)

Partial : It takes place when the prices of some goods rise owing to a temporary shortage due to crop failure, flood or rise in the price of general goods.

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Government Interference

1.

Open : When government is not interfering in market then there is apparent rise in the prices.

Inflationary process in which prices are permitted to rise without being suppressed by government price control or other control checks (Milton Fried man)

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2)

Suppressed : When price increase is controlled by

governmental interference like price control or rationing. Wartime controls is an example.

Implications Wasteful diversification of productive resources.

Price control and rationing will be unsuccessful if not implemented effectively

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TYPES OF INFLATION

1) Demand Pull Inflation:

It means that increase in demand for goods and services causes the increases in prices.

It is constructive to economy excess demand and favourable investment conditions will stimulate investment and expansion.

Increased government expenditure on goods and services for military can lead to increased demand.
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2. Cost Push Inflation : It occurs when there is an increase

in demand without increase in production in the case of goods and services where no alternatives\ substitutes are available. Its supply shock inflation.

Note : Wages increasing, Increased price of inputs, Oil prices increasing. Natural disasters

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Structural Inflation
The price of products increasing when there is a supply shortage.

It is also termed as Bottle neck Inflation.

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OTHER FORMS

1.

Profit Induced Inflation : Reduction in costs results in reduction of prices. But government will interfere to prevent such a situation.

2.

Deficit Induced Inflation : When government places when the government fails to step up its income to meet the increased expenditure and they have to cover the deficit by more currency induction.

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3)

Wage Induced : When workers force the company to increase the wages, production cost increases resulting in rise in prices.

4)

Mark-up Inflation : Monopolistic organisations analyse their production cost and they add certain mark up to yield pre decided rate of profit.

Ex :- Seen in USA.
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5)

Ratchet Inflation : It is a situation in which prices in certain sectors are not allowed to fall when there are conditions prevailing to result in a price fall.

6)

Stagflation : Inflation is accompanied stagnation on the development front or high price exist with high unemployment.

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Built in Inflation
It happens when there is a wage increase due to Inflation, and producers of goods and services passing these higher labor costs on to their customers as higher prices .

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Inflation Gap

concept by Keynes It is the excessive aggregate demand for goods and services
over their total supply.

In simple terms purchasing power is increasing but rate of

production not increasing.

An excess of anticipated expenditure over available output

at base prices ( Kurihara )

Difference between anticipated money demand for

consumption of output and the supply of the output
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IMPACT

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Keynesian Thoughts Inflation promotes economic growth.

1) 2) 3) 4)

Inflation increases profits of the entrepreneurs which increases savings which will create investment. Inflation creates more investment as profit increases more investment will happen. Optimistic sign for investors Optimal use of resources. Increase in demand for money by deficit financing which lead to increase in investment and hence aggregate output.
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Monetarist View
Inflation retards growth

1. 2. 3. 4. 5. 6.

Retards savings. Discourage Foreign capital, Investments Increase in Cost of Development projects. Lead to speculations. Aggravates BOP. Uncertainty in Future expectations and Investments.
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IMPACT

IMPACTS

INCOME EFFECT SUBSTITUTION EFFECT

PRICE EFFECT

GIFFEN GOODS

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Income effect :
Change in demand due to the change in real income.

Substitution effect
Price increases consumers are compelled to buy substitutes.

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Price effect
Increase in cost of product decreases the real income of the consumer.

Giffen Paradox\ Goods

Demand for a commodity increases even at higher prices. Exception to law of demand and supply.

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Deficit Financing

Happens in time of War and huge capital requirement for

government.

Money supply increases which causes increase in demand. Used in Developing countries for development plans.

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Inflation & Developing economies In Developing economies Inflation happens due to

1. 2. 3.

Inflation happens due to developmental effort and resultant structural change. Socio-economic political structure which determines sectoral demand and supply gaps and bottlenecks. By Myrdal and Streeten and other Latin American Economists
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Control Measures a) Monetary b) Fiscal c) Direct d) Other

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Monetary measures

1. 2. 3. 4.

Bank rate is increases, rate of interest increases which results reduction in money supply. Open market operation : Central banks sells government securities to commercial banks reducing their cash reserves. Minimum Reserve ratio- It increases. Selective credit control In developing country. It is done to divert flow of credit from unproductive and inflation sectors to growth oriented. Reducing spending Consumer durables.
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Limitations

1. 2. 3. 4. 5.

Excess reserves are there it will not affect the bank. Cost-Push inflation this measures are ineffective. Scarcity of commodities. If it happens by deficit financing, no effect In all economies money supply is there, so controlling it doesnt control inflation.

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Fiscal Measures

1. 2. 3. 4.

Increase in Taxation. Reduction in Public expenditure. Public borrowing. Control of *Deficit Financing Increase in currency issuances

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Limitations

1) 2) 3) 4)

Reduction in Govt spending affects many Welfare schemes. Govt may lack efficiency in administering fiscal measures. Success depends on stability on political system and Govt will. A combination of both is required.

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Direct Controls

1. 2. 3. 4. 5.

Rationing of Consumer goods. Price control. Hire Purchase restrictions. Industrial Licenses. Wage Freeze.

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Other Measures

1. 2. 3. 4. 5.

Raising the Level of Output. Proper Wage policy. Population control. Overvaluation of domestic currency in terms of Foreign currency. Promote savings

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Deflation:
Its the economic situation where value of money is rising or the prices are falling. (Crowther). It comes after Inflation

Reflation :
It indicates deliberate expansionary efforts to prevent a fall in prices or to stimulate a recovery of prices . Disinflation : Process of bringing down prices by contracting currency.

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THANK YOU

PGDM-1

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