ECONOMICS FOR MANAGERS

ASSIGNMENT I

NAME : VASANTHAKUMAR. B

ROLL NO :10AC41
BATCH :“C”
 INFLATION

The rate at which the general level of prices for goods and services is rising and subsequently,
purchasing power is falling. Central banks attempt to stop severe inflation, along with severe
deflation, in an attempt to keep the excessive growth of prices to a minimum.

In economics, 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, 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 are manifold and 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 over future inflation may discourage investment and savings, and
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.

Types of Inflation

There are four main types of inflation. The various types of inflation are briefed below.

Wage Inflation: Wage inflation is also called as demand-pull or excess demand inflation.
This type of inflation occurs when total demand for goods and services in an economy exceeds
the supply of the same. When the supply is less, the prices of these goods and services would
rise, leading to a situation called as demand-pull inflation.

Cost-push Inflation: As the name suggests, if there is increase in the cost of production of
goods and services, there is likely to be a forceful increase in the prices of finished goods and
services. For instance, a rise in the wages of laborers would raise the unit costs of production
and this would lead to rise in prices for the related end product. This type of inflation may or
may not occur in conjunction with demand-pull inflation.

Pricing Power Inflation: Pricing power inflation is more often called as administered price
inflation. This type of inflation occurs when the business houses and industries decide to
increase the price of their respective goods and services to increase their profit margins. A point
noteworthy is pricing power inflation does not occur at the time of financial crises and
economic depression, or when there is a downturn in the economy. This type of inflation is also
called as oligopolistic inflation because oligopolies have the power of pricing their goods and
services.
Sectoral Inflation: This is the fourth major type of inflation. The sectoral inflation takes
place when there is an increase in the price of the goods and services produced by a certain
sector of industries. For instance, an increase in the cost of crude oil would directly affect all the
other sectors, which are directly related to the oil industry. Thus, the ever-increasing price of
fuel has become an important issue related to the economy all over the world. Take the
example of aviation industry. When the price of oil increases, the ticket fares would also go up.
This would lead to a widespread inflation throughout the economy, even though it had
originated in one basic sector. If this situation occurs when there is a recession in the economy,
there would be layoffs and it would adversely affect the work force and the economy in turn.

Fiscal Inflation: Fiscal Inflation occurs when there is excess government spending. This
occurs when there is a deficit budget. For instance, Fiscal inflation originated in the US in 1960s
at the time President Lydon Baines Johnson. America is also facing fiscal type of inflation under
the president ship of George W. Bush due to excess spending in the defense sector.

Inflation in India

India has been the cynosure for the past few years in the global economic arena owing to its
changing inflation patterns. Between the fiscal year 2004-05 and 2007-2008, India had
experienced an average growth rate of more than 9%, but the global crunch pinched the
economy so hard that the economy gave in to the adverse external shocks and few sectors
experienced a slump. Inflation in India 2009 stands at 11.49% Y-o-Y. The inflation rate is
referred to the general rise in prices, taking into consideration the common man's purchasing
power. Inflation is mostly measured in CPI.

Inflation in India statistics

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2009 10.45 9.63 8.03 8.70 8.63 9.29 11.89 11.72 11.64 11.49 - -

2008 5.51 5.47 7.87 7.81 7.75 7.69 8.33 9.02 9.77 10.45 10.45 9.70

2007 6.72 7.56 6.72 6.67 6.61 5.69 6.45 7.26 6.40 5.51 5.51 5.51

2006 4.39 5.31 5.31 5.26 6.14 7.89 6.90 5.98 6.84 7.63 6.72 6.72
 DEFLATION

In economics, deflation is a decrease in the general price level of goods and services. Deflation
occurs when the annual inflation rate falls below zero percent (a negative inflation rate),
resulting in an increase in the real value of money – allowing one to buy more goods with the
same amount of money. This should not be confused with disinflation, a slow-down in the
inflation rate (i.e. when inflation declines to lower levels). As inflation reduces the real value of
money over time, conversely, deflation increases the real value of money – the functional
currency (and monetary unit of account) in a national or regional economy.

Currently, economists generally believe that deflation is a problem in a modern economy

because of the danger of a deflationary spiral (explained below). Deflation is correlated with
recessions including the Great Depression, as banks defaulted on depositors. Additionally,
deflation may cause the economy to enter the liquidity trap. However, historically not all
episodes of deflation correspond with periods of poor economic growth.

Effects of deflation

In the IS/LM model (that is, the Investment and Saving equilibrium/ Liquidity Preference and
Money Supply equilibrium model), deflation is caused by a shift in the supply and demand curve
for goods and services, particularly a fall in the aggregate level of demand. That is, there is a fall
in how much the whole economy is willing to buy and the going price for goods. Because the
price of goods is falling, consumers have an incentive to delay purchases and consumption until
prices fall further, which in turn reduces overall economic activity.

Since this idles capacity, investment also falls, leading to further reductions in aggregate
demand. This is the deflationary spiral. An answer to falling aggregate demand is stimulus,
either from the central bank, by expanding the money supply, or by the fiscal authority to
increase demand, and to borrow at interest rates which are below those available to private
entities.

In more recent economic thinking, deflation is related to risk: where the risk-adjusted return on
assets drops to negative, investors and buyers will hoard currency rather than invest it, even in
the most solid of securities. This can produce a liquidity trap. A central bank cannot, normally,
charge negative interest for money, and even charging zero interest often produces less
simulative effect than slightly higher rates of interest. In a closed economy, this is because
charging zero interest also means having zero return on government securities, or even
negative return on short maturities. In an open economy it creates a carry trade, and devalues
the currency producing higher prices for imports without necessarily stimulating exports to a
like degree.

In monetarist theory, deflation must be associated with either a reduction in the money supply,
a reduction in the velocity of money or an increase in the number of transactions. But any of
these may occur separately without deflation. It may be attributed to a dramatic contraction of
the money supply, or to adhere to a gold standard or other external monetary base
requirement.

Deflation is generally regarded negatively, as it causes a transfer of wealth from borrowers and
holders of illiquid assets, to the benefit of savers and of holders of liquid assets and currency. In
this sense it is the opposite of inflation, which is similar to taxing currency holders and lenders
(savers) and using the proceeds to subsidize borrowers. Thus inflation may encourage short
term consumption. In modern economies, deflation is usually caused by a drop in aggregate
demand, and is associated with recession and (more rarely) long term economic depressions.

Causes of deflation

In mainstream economics, deflation may be caused by a combination of the supply and demand
for goods and the supply and demand for money, specifically the supply of money going down
and the supply of goods going up. Historic episodes of deflation have often been associated
with the supply of goods going up (due to increased productivity) without an increase in the
supply of money, or (as with the Great Depression and possibly Japan in the early 1990s) the
demand for goods going down combined with a decrease in the money supply. Studies of the
Great Depression by Ben Bernanke have indicated that, in response to decreased demand, the
Federal Reserve of the time decreased the money supply, hence contributing to deflation.

Basic types of deflation

Some types of deflation can be distinguished.

On the demand side:

 Growth deflation. (Increase in the supply of goods. Decrease in CPI)

 Cash building (hoarding) deflation (More savings of cash. Decrease in velocity of money.
Increase in the demand for money)

On the supply side:

 Bank credit deflation. (Decrease in the bank credit supply by bankruptcy or contraction
of the money supply by the central bank)

Money supply side type deflation

From a monetarist perspective deflation is caused primarily by a reduction in the velocity of
money and/or the amount of money supply per person.
 TRADE CYCLE

The trade cycle refers to the ups and down in the level of economic activity which extend over
to a period of several years. The trade cycle come in the capitalistic economies.

J.M. Keynes says, "A trade cycle is composed of periods of good trade characterized by rising
prices and low unemployment percentage, with periods of bad trade characterized by following
prices and high unemployment percentages."

Hansen says, "That business cycle is a fluctuation in employment, output and prices".

A cycle has different phases like expansion, recession, contraction and revival. The duration of
business cycle may be one year to ten or twelve years. There are four phases of business cycle
one of these is boom or phase of prosperity. Boom or Phase of Prosperity: This phase is
characterized by high economic activities and increasing production employment, profit,
national income, investment, wages and volume of bank credit.

The general mode of business is that of optimism. New plants are setup and old planes are fully
utilized. There is great demand of commodities due to increase in income and employment,
businessmen earn high profit and standard of living is high but after some time, the boom
should reach full employment level.

The general mode of business is that of optimism. New plants are setup and old planes are fully
utilized. There is great demand of commodities due to increase in income and employment,
businessmen earn high profit and standard of living is high but after some time, the boom
should reach full employment level.

 TYPES OF CYCLES

The Short Kitchin Cycle: - It is also known as the minor cycle, which is of approximately 40
months duration.  It is famous after the name of the British economist Joseph Kitchin, who
made a distinction between a major and a minor cycle in 1923.  He came to the conclusion on
the basis of his research that a major cycle is composed of two or three minor cycles of 40
months.

The Long Jugler Cycle: - This cycle is also known as the major cycle.  It is defined “as the
fluctuation of business activity between successive crises.”  In 1862 Clement Jugglers, a French
economist showed that periods of prosperity, crises and liquidation followed each other always
in the same order.  Later economists have come to the conclusion that Juggler cycle’s duration
is on the average nine and a half years.

The Very Long Kondratieff Cycle:-  In 1925, N.D. Kondratieff, the Russian economist,
came to the conclusion that there are longer waves of cycles of more than 50 years duration,
made of six Jugler cycles.  A very long cycle has come to be known as the Kondratieff wave.

Building Cycles: - Another type of cycle relates to the construction of buildings which is of
fairly regular duration.  Its duration is twice that of the major cycles are associated with the
name of Warren and Pearson, two American economists who came to this conclusion in World
Prices and the Building Industry (1937).

Accordingly, there are five phases of trade cycle:

1. Inflation: When the economic activity increases after full employment level, it is called
inflation. During inflation, the demand pressures will be high. Increasing demand leads to
increasing product prices, increasing demand for factors, higher wages and then increasing
demand again.

2. Boom: Boom refers to the peak in the level of economic activity after full employment. The
demand pressures will be at the peak. The price level will be very high.

3. Deflation: It is the downward trend in the economic activities after boom. At boom level
the Government will take corrective measures due to which the economic activity will show a
change in trend.

4. Recession: When the economic activity reduces below full employment It is called
recession. The level employment will decreases, the prices will decrease and the economic
activity shrinks.

5. Depression: This is the lowest level of economic activity. The market’s collapse. Large
scale unemployment will lead to poverty and suffering. The world experienced Great
depression during 1929 and 1933.

6. Recovery: From the lowest levels of economic activity the markets recover due to
positive Government policy. The economic activity will increase towards full employment.
Three will be increase in the level of employment, incomes, investment and demand.
 NATIONAL INCOME

Annual income of a family is the sum total of income it receives from various sources during a
year. It is on this basis that the economic position of a family is determined. Therefore, when
we calculate the annual income of a nation, naturally we have to take into account the income
from various sectors.

J.M.Keynes, a famous economist defined national income as follows.

"National Income is the money value of all goods and services produced in a country during a
year"

While family income reflects the economic position of households, national income shows the
economic position of a nation. The basic objective of an economy is to achieve economic
progress. This is achieved by coordinating natural resources, human resources, capital,
technology etc. National income will help to assess and compare the progress achieved by a
country over a period of time. Let us see why the study of national income is given so much
importance.

Measures of national income and output

A variety of measures of national income and output are used in economics to estimate total
economic activity in a country or region, including gross domestic product (GDP), gross national
product (GNP), and net national income (NNI). All are especially concerned with counting the
total amount of goods and services produced within some "boundary". The boundary may be
defined geographically, or by citizenship; and limits on the type of activity also form part of the
conceptual boundary; for instance, these measures are for the most part limited to counting
goods and services that are exchanged for money: production not for sale but for barter, for
one's own personal use, or for one's family, is largely left out of these measures, although some
attempts are made to include some of those kinds of production by imputing monetary values
to them.

National income and welfare

GDP per capita (per person) is often used as a measure of a person's welfare. Countries with
higher GDP may be more likely to also score highly on other measures of welfare, such as life
expectancy. However, there are serious limitations to the usefulness of GDP as a measure of
welfare:
  Measures of GDP typically exclude unpaid economic activity, most importantly domestic
work such as childcare. This leads to distortions; for example, a paid nanny's income
contributes to GDP, but an unpaid parent's time spent caring for children will not, even
though they are both carrying out the same economic activity.

 GDP takes no account of the inputs used to produce the output. For example, if
everyone worked for twice the number of hours, then GDP might roughly double, but
this does not necessarily mean that workers are better off as they would have less
leisure time. Similarly, the impact of economic activity on the environment is not
measured.

 Comparison of GDP from one country to another may be distorted by movements in

exchange rates. Measuring national income at purchasing power parity may overcome
this problem at the risk of overvaluing basic goods and services, for example subsistence
farming.

 GDP does not measure factors that affect quality of life, such as the quality of the
environment (as distinct from the input value) and security from crime. This leads to
distortions - for example, spending on cleaning up an oil spill is included in GDP, but the
negative impact of the spill on well-being (e.g. loss of clean beaches) is not measured.

 GDP is the mean (average) wealth rather than median (middle-point) wealth. Countries
with a skewed income distribution may have a relatively high per-capita GDP while the
majority of its citizens have a relatively low level of income, due to concentration of
wealth in the hands of a small fraction of the population.

Methods of calculating National Income

Production Method: This method is based on the total production of a country during a
year. First of all production units are classified into primary, secondary and tertiary sectors.

Income Method: Factors of production together produce output and income. The income
received by the factors of production during a year can be obtained by adding rent to land,
wages to labour, interest to capital and profit to organizations. This will be equal to the income
of the nation.

Expenditure Method: National income can also be calculated by adding up the

expenditure incurred for goods and services. Government as well as private individuals spend
money for consumption and production purposes. The sum total of expenditure incurred in a
country during a year will be equal to national income.
 ECONOMIC LEGISLATION

“God did not create all of us equal; he created some more equal than others.” –
Anon

There is considerable disparity in the economic status of various countries of the world.
According to the Human Development Report prepared by the United Nations, in 2007, GDP
per capita across the world ranged from a high of USD 103,042 in Luxembourg to a low of USD
115 in Burundi. The question is what causes these differences? Is it merely the availability of
natural resources; or is it something more to do with the entrepreneurial nature of its people,
or indeed is it to do with different forms of government or legislations? This article seeks to
analyze the role of legislation and ‘rule of law’ in economic development. It also includes a
short analysis of India and China to give some insight on such experiences.

The real challenge:

What is important to note in the above analysis is that it was not the mere availability of
legislation that ensured economic growth, but the ‘institutions’ which helped enforce them.
Generally, the success of legislation can be gauged on the following areas:

(i) Design i.e. developing the law in a participatory manner,

(ii) Implementation i.e. mechanism for application or enforcement of the law,

(iii) Monitoring i.e. system of reviewing the performance of law, and

(iv) Revision i.e. modification of law where necessary to achieve the objectives of legislation.

In most countries, while there is understandable enthusiasm in the design phase, the real
challenge is the other three areas – most notably in Implementation or enforcement. This is
then the real challenge which countries face and on which depends their success or failure.

Sustainable Economic Growth is a product of both process and content of legislation. It

demands accountability, transparency, certainty, competitiveness, continuous improvement,
efficiency, innovation, integration, evidence -based decision making, and shared responsibility.
Economic legislation should hence facilitate these.

Corruption
Concern about corruption is as old as the history of government. Broadly defined, corruption is
the abuse of public office for private gain and includes bribery, nepotism, extortion, black
market etc. Dr C Rangarajan says that “the negative consequences of corruption are well
known but not well realized. Corruption is anti-national, anti-development and anti-poor.
There are documented studies to show that corruption impedes growth, inhibits potential
investment, increases inefficiency and breeds vested interests.”

A study by IMF on corruption (1997)5 finds that corruption is negatively linked to the level of
investment and economic growth, that is to say, the more corruption, the less investment and
the less economic growth. Analysis further shows that if the corruption index improves by one
standard deviation (equal to 2.38 in this case—a standard deviation measures variation from
the “normal” index), the investment rate increases by more than 4 percentage points and the
annual growth rate of per capita GDP increases by over a half percentage point. In effect, a
country that improves its standing on the corruption index from, say, 6 to 8 (recall that 0 is
most corrupt, 10 least), will enjoy the benefits of an increase of 4 percentage points of
investment, with consequent improvement in employment and economic growth.

The case of India

India would be among the most over-legislated countries in the world today. Starting with the
Acts left by the British, the government has been over-enthusiastic in promulgating new laws as
the solutions for myriad problems. Most recently, the Right of Children to Free and Compulsory
Education Act is a case in point. After trying in vain to achieve higher literacy levels and provide
free primary education to all, the only response has been to enact a law that will ensure this.

The problem with India is not new – it stems from the earlier practice of using the tax-subsidy
continuum to influence behaviour. Ronald Reagan’s quote about government policies is
instructive:

“If it moves, tax it; if it keeps moving, regulate it; and if it stops moving, subsidize it.”

Economic Growth
‘Economic growth’ is defined in economic terms as the increase in value of goods and services
produced by an economy and conventionally measured by the increase in real gross domestic
product (GDP). However, since the Rio Declaration of 1992, there has been a growing focus on
‘sustainable economic growth’. The Brundtland Commission or what is formally called the
World Commission on Environment and Development in its seminal publication Our Common
Future (1987) defines Sustainable Development as ‘Development that meets the needs of the
present without compromising the ability of future generations to meet their own needs.’

Hence, in our context, the real test of development is not only economic growth but what is
known as ‘sustainable development’.