INFLATION

INFLATION : NATURE

SCOPE AND CONTROL

• INFLATION is a rise in the general level of prices

of goods and services in an economy over a

period of time. When the general price level

rises, each unit of currency buys fewer goods

and services.

MEANING OF INFLATION

INTRODUCTION

Inflation is defined as a sustained increase in the

price level or a fall in the value of money.

It is measured as a rate percentage per unit time, say

a year or month.

When the level of currency of a country exceeds the

level of production, inflation occurs.

Value of money depreciates with the occurrence of

inflation.

VARIATIONS ON INFLATION Deflation is when the general level of prices is falling. This

is the opposite of inflation.

Hyper inflation is unusually rapid inflation. In extreme

cases, this can lead to the breakdown of a nation's monetary

system.

Stagflation is the combination of high unemployment and

economic stagnation with inflation..

RATE OF INFLATION

Rate of inflation is the rate of change of the general price level. It is measured by simple formula:

Rate of inflation t=Pt-Pt-1 Pt-1

Where, Pt=price level in the year t

Pt-1=price level in the year t-1,the base year

If there is a decline in the rate of inflation such a situation is called DISINFLATION.

EFFECTS OF INFLATION

Investment

Interest rates

Exchange rates

Unemployment

Stocks

Decrease in the purchasing power

Change the allocation of income

CAUSES OF INFLATION

FACTORS ON DEMAND SIDE:

Increase in money supplyIncrease in disposable incomeDeficit financingForeign exchange reserves

FACTORS ON SUPPLY SIDE

oRise in administered prices

oErratic agriculture growth

oAgricultural price policy

oInadequate industrial growth

CAUSES OF INFLATION

Demand-Pull Inflation

This theory can be summarized as "too much money

chasing too few goods". This usually occurs in growing

economies. The demand for goods and services increases and

production remains the same or does not increase as fast. the excess demand results in prices being “pulled up”.

Demand pull inflation occurs when total demand for goods and services exceeds the total supply.

This type of inflation happens when there is an inflationary gap

Demand Pull Inflation

P2

P1

Q2Q1

Aggregate Supply

Aggregate Demand 2

Aggregate Demand 1

Price

Real GDP

COST-PUSH INFLATION

When companies' costs go up, they need to increase prices

to maintain their profit margins.

Caused by an increase in the cost of production. Increased

costs “push up” the price level.

Cost push inflation can result from change in aggregate

supply.

The two main sources of change in aggregate supply are

increase in wage rate and price of raw material.

12

Cost Push Inflation

P2

P1

Q2 Q1

Aggregate Supply 2

Aggregate Demand

Price $

Real GDP ($)

Aggregate Supply 1

HOW TO CONTROL INFLATION

Monetary

Measures

Other Measure

s

Fiscal Measure

s

MONETARY MEASURES

Credit Control central bank should pursue credit control policy. In

order to control cash reserve ratio etc. it can also issue notice to other

banks in order to control credit.

• Deficit Financing It means printing of new currency notes by Reserve

Bank of India .If more new notes are printed it will increase the supply

of money thereby increasing demand and prices.

Issue of New Currency During Inflation the RBI will issue new currency

notes replacing many old notes. This will reduce the supply of money in

the economy.

Fiscal Measures

Reduction in Unnecessary Expenditure

Increase in Taxes

Increase in Savings

Public Debt

Imposition of new Taxes

Wage Control

Rationing

Maintaining Surplus Budget

OTHER MEASURES

To Increase Production

Rational Wage Policy

Price Control

Increase in Imports of Raw materials

2. Decrease in Exports

4. Provision of Subsidies

5. Use of Latest Technology

6. Rational Industrial Policy

HOW IS IT MEASURED

Consumer Price Index

Wholesale Price Index

CONSUMER PRICE INDEX

CPI is a measure estimating the average price of consumer

goods and services purchased by households.

CPI measures a price change for a constant market basket of

goods and services from one period to the next within the same

area (city, region, or nation).

It is a price index determined by measuring the price of a

standard group of goods meant to represent the typical market

basket of a typical urban consumer. The percent change in the CPI

is a measure estimating inflation.

WHOLESALE PRICE INDEX

WPI was published in 1902,and was one of the economic

indicators available to policy makers until it was replaced by

most developed countries by the CPI market. index in the

1970.

WPI is the index that is used to measure the change in the

average price level of goods traded in wholesale market.

Some countries (like India and The Philippines) use WPI

changes as a central measure of inflation. However, India and

the United States now report a producer price index instead.

PROBLEMS WITH WPI

In present day service sector plays a key role in Indian

economy. Consumers are spending loads of money on

services like education and health. And these services are

not incorpated in calculation of WPI.

WPI measures general level of price changes either at level

of wholesaler or at the producer and does not take into

account the retail margins.

WPI is supposed to measure impact of prices on business.

“But we use it to measure the impact on consumers. Many

commodities not consumed by consumers get calculated in

the index.

INFLATION - KEYNESIAN VIEW

Keynesian economics proposes that changes in money

supply do not directly affect prices, and that visible inflation is

the result of pressures in the economy expressing themselves

in prices.

Demand-pull inflation is caused by increases in

aggregate demand due to increased private and

government spending.

Cost-push inflation, also called "supply shock inflation," is

caused by a drop in aggregate supply (potential output).

This may be due to natural disasters, or increased prices of

inputs.

For example, a sudden decrease in the supply of oil,

leading to increased oil prices, can cause cost-push

inflation.

MONETARIST VIEW

Consider fiscal policy, or government spending and

taxation, as ineffective in controlling inflation.The quantity theory of money, simply stated, says that any change in the amount of money in a system will change the price level.

MV = PQ

where

M is the nominal quantity of money.

V is the velocity of money in final expenditures;

P is the general price level;

Q is an index of the real value of final expenditures;

THE PHILLIPS CURVE

Wage growth % (Inflation)

Unemployment (%)

The Phillips Curve shows an inverse relationship between inflation and unemployment. It suggested that if governments wanted to reduce unemployment it had to accept higher inflation as a trade-off.

Money illusion – wage rates rising but individuals not factoring in inflation on real wage rates.

1.5%

6%4%

2.5%

PC1

INDIA INFLATION RATE

The inflation rate in India was recorded at 8.59 percent in April of 2014.

Inflation Rate in India averaged 9.67 Percent from 2012 until 2014, reaching an all time

high of 11.16 Percent in November of 2013 and a record low of 7.55 Percent in January of

2012.

Inflation Rate in India is reported by the Ministry of Commerce and Industry, India.

The inflation rate in India was last reported at 8.8 percent in February of 2012.

From 1969 until 2010, the average inflation rate in India was 7.99 percent reaching an

historical high of 34.68 percent in September of 1974 and a record low of -11.31 percent in

May of 1976.

THANK YOU

SREEKANTH.K.TMSc.AGRICULTURAL ECONOMIICS

PAJANCOA & RI