What is inflation??

Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services; consequently, annual inflation is also erosion in the purchasing power of money a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time. Inflation's effects on an economy can be simultaneously positive and negative. Negative effects of inflation include a decrease in the real value of money and other monetary items over time; uncertainty about future inflation may discourage investment and saving, or may lead to reductions in investment of productive capital and increase savings in non-producing assets. e.g. selling stocks and buying gold. This can reduce overall economic productivity rates, as the capital required to retool companies becomes more elusive or expensive. High inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include a mitigation of economic recessions, and debt relief by reducing the real level of debt. High rates of inflation and hyperinflation can be caused by an excessive growth of the money supply. Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in realdemand for goods and services, or changes in available supplies such as during scarcities, as well as to growth in the money supply. However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth. Today, most mainstream economists favour a low steady rate of inflation. Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labour market to adjust more quickly in a downturn, and reduce the risk that a liquidity trap prevents monetary policy from stabilizing the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control the size of the money supply through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements.

Demand pulled inflation??

Demand-pull inflation arises when aggregate demand in an economy outpaces aggregate supply. It involves inflation rising as real gross domestic product rises and unemployment falls, as the economy moves along the Phillips curve. This is commonly described as "too much money chasing too few goods". More accurately, it should be described as involving "too much money spent chasing too few goods", since only money that is spent on goods and services can cause inflation. This would not be expected to persist over time due to increases in supply, unless the economy is already at a full employment level.

The term demand-pull inflation is mostly associated with Keynesian economics. According to Keynesian theory, the more firms will employ people, the more people are employed, and the higher aggregate demand will become. This greater demand will make firms employ more people in order to output more. Due to capacity constraints, this increase in output will eventually become so small that the price of the good will rise. At first, unemployment will go down, shifting AD1 to AD2, which increases Y by (Y2 - Y1). This increase in demand means more workers are needed, and then AD will be shifted from AD2 to AD3, but this time much less is produced than in the previous shift, but the price level has risen from P2 to P3, a much higher increase in price than in the previous shift. This increase in price is called inflation.

Cost pulled inflation??

Cost-push inflation is a type of inflation caused by substantial increases in the cost of important goods or services where no suitable alternative is available. A situation that has been often cited of this was the oil crisis of the 1970s, which some economists see as a major cause of the inflation experienced in the Western world in that decade. It is argued that this inflation resulted from increases in the cost of petroleum imposed by the member states of OPEC. Since petroleum is so important to industrialised economies, a large increase in its price can lead to the increase in the price of most products, raising the inflation rate. This can raise the normal or built-in inflation rate, reflecting adaptive expectations and the price/wage spiral, so that a supply shock can have persistent effects. Keynesians argue that in a modern industrial economy, many prices are sticky downward or downward inflexible, so that instead of prices falling in this story, a supply shock would cause a recession, i.e., rising unemployment and falling gross domestic product. It is the costs of such a recession that likely causes governments and central banks to allow a supply shock to result in inflation. They also note that though there was no deflation in the 1980s, there was a definite fall in the inflation rate during this period. Actual deflation was prevented because supply shocks are not the only cause of inflation; in terms of the modern triangle model of inflation, supply-driven deflation was counteracted by demand-pull inflation and built-in inflation resulting from adaptive expectations and the price/wage spiral. Monetarist economists such as Milton Friedman argue against the concept of cost-push inflation because increases in the cost of goods and services do not lead to inflation without the government and its central bank cooperating in increasing the money supply. The argument is that if the money supply is constant, increases in the cost of a good or service will decrease the money available for other goods and services, and therefore the price of some those goods will fall and offset the rise in price of those goods whose prices have increased. One consequence of this is that monetarist economists do not believe that the rise in the cost of oil was a direct cause of the inflation of the 1970s. They argue that although the price of oil went back down in the 1980s, there was no corresponding deflation.

Controlling inflation
Monetary policies

Today the primary tool for controlling inflation is monetary policy. Most central banks are tasked with keeping the federal funds lending rate at a low level, normally to a target rate around 2% to 3% per annum, and within a targeted low inflation range, somewhere from about 2% to 6% per annum. A low positive inflation is usually targeted, as deflationary conditions are seen as dangerous for the health of the economy. There are a number of methods that have been suggested to control inflation. Central banks such as the U.S. Federal Reserve can affect inflation to a significant extent through setting interest rates and through other operations. High interest rates and slow growth of the money supply are the traditional ways through which central banks fight or prevent inflation, though they have different approaches. For instance, some follow a symmetrical inflation target while others only control inflation when it rises above a target, whether express or implied. Monetarists emphasize keeping the growth rate of money steady, and using monetary policy to control inflation (increasing interest rates, slowing the rise in the money supply). Keynesians emphasize reducing aggregate demand during economic expansions and increasing demand during recessions to keep inflation stable. Control of aggregate demand can be achieved using both monetary policy and fiscal policy (increased taxation or reduced government spending to reduce demand).
Fixed exchange rate

Under a fixed exchange rate currency regime, a country's currency is tied in value to another single currency or to a basket of other currencies (or sometimes to another measure of value, such as gold). A fixed exchange rate is usually used to stabilize the value of a currency, vis-avis the currency it is pegged to. It can also be used as a means to control inflation. However, as the value of the reference currency rises and falls, so does the currency pegged to it. This essentially means that the inflation rate in the fixed exchange rate country is determined by the inflation rate of the country the currency is pegged to. In addition, a fixed exchange rate prevents a government from using domestic monetary policy in order to achieve macroeconomic stability. Under the Bretton Woods agreement, most countries around the world had currencies that were fixed to the US dollar. This limited inflation in those countries, but also exposed them to the danger of speculative attacks. After the Bretton Woods agreement broke down in the early 1970s, countries gradually turned to floating exchange rates. However, in the later part of the 20th century, some countries reverted to a fixed exchange rate as part of an attempt to control inflation. This policy of using a fixed exchange rate to control inflation was used in many countries in South America in the later part of the 20th century (e.g. Argentina (19912002), Bolivia, Brazil, and Chile).

GDP:
The gross domestic product (GDP) or gross domestic income (GDI) is a measure of a country's overall economic output. It is the market value of all final goods and services made within the borders of a country in a year. It is often positively correlated with the standard of living, though its use as a stand-in for measuring the standard of living has come under increasing criticism and many countries are actively exploring alternative measures to GDP for that purpose. GDP can be determined in three ways, all of which should in principle give the same result. They are the product (or output) approach, the income approach, and the expenditure approach. The most direct of the three is the product approach, which sums the outputs of every class of enterprise to arrive at the total. The expenditure approach works on the principle that all of the product must be bought by somebody, therefore the value of the total product must be equal to people's total expenditures in buying things. The income approach works on the principle that the incomes of the productive factors ("producers," colloquially) must be equal to the value of their product, and determines GDP by finding the sum of all producers' incomes. Example: the expenditure method: GDP = private consumption + gross investment + government spending + (exports imports), or

In the name "Gross Domestic Product," "Gross" means that GDP measures production regardless of the various uses to which that production can be put. Production can be used for immediate consumption, for investment in new fixed assets or inventories, or for replacing depreciated fixed assets. If depreciation of fixed assets is subtracted from GDP, the result is called the Net domestic product; it is a measure of how much product is available for consumption or adding to the nation's wealth. In the above formula for GDP by the expenditure method, if net investment (which is gross investment minus depreciation) is substituted for gross investment, then net domestic product is obtained. "Domestic" means that GDP measures production that takes place within the country's borders. In the expenditure-method equation given above, the exports-minus-imports term is necessary in order to null out expenditures on things not produced in the country (imports) and add in things produced but not sold in the country (exports). Economists (since Keynes) have preferred to split the general consumption term into two parts; private consumption, and public sector (or government) spending. Two advantages of dividing total consumption this way in theoretical macroeconomics are:

Private consumption is a central concern of welfare economics. The private investment and trade portions of the economy are ultimately directed (in mainstream economic models) to increases in long-term private consumption. If separated from endogenous private consumption, government consumption can be treated as exogenous. so that different government spending levels can be considered within a meaningful macroeconomic framework.

Gross domestic product comes under the heading of national accounts, which is a subject in macroeconomics. Economic measurement is called econometrics.

Per capita income

Per capita income means how much each individual receives, in monetary terms. It is the measure of the amount of money that each person earns in the country, of the yearly income generated in the country. This is what each citizen is to receive if the yearly national income is divided equally among everyone. Per capita income is usually reported in units of currency per year. When comparing nations per capita income reflects gross national product per person, but it is also used to compare municipalities within nations. When determining the per capita income of a community, the total personal income is divided by the population.

Per capita income as a measure of wealth

Per capita income is often used as a measure of the wealth of the population of a nation, particularly when comparing countries with substantially different levels of wealth, however, it has several weaknesses as a measurement. Economic activity that does not result in monetary income, such as services provided within the family, or for barter, are usually not counted. The importance of these services will vary widely between different economies, both between countries and among different groups within a country. As for the per capita income of the majority of the population, using the median income or Amartya Sen's welfare function is the more appropriate approach. Differing currency exchange rates between countries mean that a given amount of money (for example, one US dollar) has differing values in different places.The total income is compared between each country or state comparing the total income tells the average income... hence we compare the average income which is the total income divided by the total population... the average income is called as per capita income