INFLATION & STAGFLATION

Definition According to Sir J.M. Keynes, “The True Inflation Refers To The Rise In The Price Levels After The Point Of Full Employment.”

Features Of Inflation • Inflation is a dynamic process.• This process is not recognizing in its initial stage. A stage increase in price level is

not termed as inflation instead of continue .Increase in price is inflation.• Increase in price always takes place in broader area, means to say, inflation

generally causes increase in prices of al l commodities, not only in prices of so me special goods.

• The main characteristics of inflation is surplus of demand over supply• Inflation hits the middle and poor class of society It results in decline the

purchasing power of consumers.

PROF. D.C. ROWAN

R(i) = p(f) R(i)= the rate of inflationP = the price levelF and (1-f)=the period of calendar time of observation = the change to be observed

p(1-F) * 100

Cause Of Inflation • As inflation is a continuous rise in the general price level, it is

mainly caused by: The increase in demand, and/or. The increase in cost of production. Thus, the two important causes of inflation.

Demand-Pull Inflation Cost-Push Inflation

Demand Pull Inflation Demand-Pull Inflation is also called Excess-Demand Inflation.

Demand-Pull Implies that Demand for Goods and Services is Pulled Above the Capacity of the Economy to Produce Goods and Services in a Given Period.

It refers to that types of inflation which arises due to aggregate demand for goods and services being more than the supply of goods and services.

Diagram

Q

P2

P1

P

Y

0 X

S

E2

E1

E

D2

D1

D D2

D1

DS

PRICE

LEVEL

REAL OUPUT

Factors Responsible For The Demand Pull Inflation

Increase In Money Supply

Size Of The Population

Credit Creation

Black Money Export Trade Public Dept.

Cost Push Inflation Cost- push inflation refers to the rise in the price level due to a rise in

cost of production.

Contrary to demand pull inflation, some economists are of the opinion that a rise in cost of production is the root cause for inflation and this inflation is also termed as “ cost inflation.”

The price level rises due to the rise in the cost of production, when the factor owners tend to raise factor prices or increase their share in total output.

DiagramY

P4

P3P2

P1P

S

D2

D1

D G

F

S2

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Q Q1 Q2

D1

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XREAL OUPUT

PRICE

LEVEL

E2

E1

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O

Factors Responsible For The Cost Push Inflation

Higher Wages

Material Costs

Profit Margin

Natural Calamities

Other Factors

Inflationary Gap:• In order to analyse the pressure of inflation, the concept of inflationary gap

was introduced by J.M. Keynes in his pamphlet “How to pay for the war.”• The inflationary gap refers to an excess of anticipated aggregate

expenditure out of the disposal income of the people over the money value of available aggregate output of goods and services at their base-year or constant prices.

• In the simple words, the inflationary gap is the difference between the aggregate money demand for the consumer goods and services and their supply.

Diagram:-

F

R

0 Y Y1 Y2

45

E2C1+I1+G1

C+I+G

C

Y=E

F1E1

E

INCOME (Y)

EXPENDITURE(E)

Y

X

• Inflation is concerned with –• 1)Rapidly rise in the prices of goods and services, and• 2)Consequently fall in the value of money

Effects Of Inflation

On Production On Distribution On Socio-Political Stability Decrease in value of money Wages and Salary earners Class-ConflictDecrease in value foreign investment Fixed income groups Political-instability Hoarding of essential goods Entrepreneurs

• Inflation is concerned with –• 1)Rapidly rise in the prices of goods and services, and• 2)Consequently fall in the value of money

Measures to Control Inflation

Money measures Fiscal measures Miscellaneous measures Bank Rate Government Expenditure Expansion on Output Government Securities Taxation Wage Policy Cash Reserve Ration Public Borrowing Price Control and Rationing

Deflation:• On the contrary to inflation, deflation is a situation occurs with a continuous fall in

the general level of prices.• A.C Pigou defines the deflation as…….• “A state of falling prices which occurs at the time when the output of goods and

services more rapidly than the volume of money income in the economy.”• After the 1930’s depression, deflation has become very rare situation to the world.

Usually, deflation may results in:1. A continuous fall in the general price level,2. An increase in the value of money, 3. An increase in the unemployment,4. A decline in effective demand, and 5. The adverse effects on the economy.

Stagflation• Stagflation refers to the situation when a high inflation

occurs along with high unemployment.• The term ‘stagflation’ was coined in the seventies (1973)

in several developed countries, when the rapid increase in oil prices lead to sharp increases in the prices of manufactured goods, and the real GNP declined while the rate of unemployment increased.

DiagramAS1

AS

AD

AD1AS1

AS

E1

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Q1 Q

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REAL OUPUT

PRICE

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