13 jNF LATION po ee Meaning and Cau. e ; ses of Inflation e Price Index and Nationa] Inco, ni Inflation in India ne Deflator e Measures to Control Inflation since it has considerable impact on the average namic variable in India ypward movement in the general prices of piods ant It Tefers to an estimated as the percentage rate of change in aprice Fee Services and is time period. over the reference BOSS MEANING Money is used as a measuring rod to measure the value of goods and services. A measuring rod is expected to be stable in its value like metre, litre, kilogram etc. Unfortunately money as a measuring rod does not remain stable in its value. Value of money refers to its purchasing power which depends on price level. Value of money and price level are inversely related. Acontinuous increase in general price level is called inflation. A mere high level of general price need not be inflationary. It is a process where there is asustained rise in general price level. id enable us to understand Afew definiti ifferent economists woul ‘ itions from di g to Professor Ackley is _ aed et the meaning of inflation better. Inflation accordins ‘persistent and appreciable rise in the » general lev , Wein price to be termed aS inflationary it must “cording to Pigou, inflation comes in existence “W. sistent and high. hen money income 1SEconomic Environment of Business (Mug 242 jn proportion to income earning a i than in Pp’ : expanding eel price Jevel takes place oat ple “have : increase. in. 8 end against less £0 ds and serve : _ Crowther m : income esisely when he says; inflation ein whick Be : : fieanin . . isin: i eee is falling rices rist 2 ‘ “on has certain distinct characteristics. It is a Situatjy Hanes jum, where there is too much money and too few R004, ae The ‘yantity or supply of money is far in excess of 5, Say ce ae It is a situation where there is a persistent incre! ee ip i Jevel. A sporadic or temporary rise In price cannot be in in] eration, Similarly it refers to a general price level and not seoigay ae of individual commodity. It, therefore, 1s @ macroecong, Ee cmenon and not a micro- economic. qt feeds on itself : once stared is difficult to check its growth or highly difficult to reverse. The importay, | factors responsible for inflation are either excess demand or increase p 4 cost or both. ; CAUSES OF INFLATION Inflation, being a state of continuous increase in price level, is mainly caused by excess demand and/or increase in supply price. Broadly speaking the factors responsible for inflation can be discussed under ‘demand pull inflation’ and ‘cost-push inflation’. [A] DEMAND-PULL INFLATION Demand-pull inflation is also called excess-demand inflation. Demané- 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. Factors responsible for demand-pull or excess demand are discussed below. () Inerease in money supply : When the monetary authorities incre” Es read supply in excess of the supply of goods and services! esults in additional demand and consequent increase in price lev?" (ii) period. » Prices would still increase during the gestjon ieee ion: rei ae Credit Creation : Commercial banks increase the quantity of money Gi) Grculation when they advan I jn circulation w Ce loans throu, h credit i i creation is similar to that of deficit financing in its eae fe wv) Repayment of public Debt : Public debt is a common feature of modern governments. When such debts are tepaid, people will havi more income at their disposal. Additional disposable income tends ie raise the demand for goods and services, ~ = (vi) Black money : Social and economic evils like Corruption, tax evasion, smuggling and other illegal activities give rise to unaccounted or black money. People with black money indulge in extravaganza, affecting demand and thus the price level. (vii) Population : The size of the population is one of the important determinants of demand. In many developing countries population is large in size and still increasing. India provides an example where demand outstrips supply due to the large and increasing population. [8] COST-PUSH INFLATION Inflation may take place independent of demand forces. Given the demand, price level may go up due to an increase in cost or supply price. The main factors affecting cost are wages, material cost, profits (mark-up) and others which have direct or indirect influence on the cost. Let us have a brief tiplanation of these factors. {) Fluctuation in Output and Supply : Fluctuations in cup ane Supply, especially of foodgrains and essential co oa oe to inflationary tendencies in the economy. In this respect, A ing ‘ essential commodities by farmers and traders leads to rise in prices. in wages it is called many factors besides ‘tant role in succeed in granted in fi Wages : When prices increase due to increase i i i d by Wage-push inflation. Wages are influence y fae the demand and supply forces. Trade unions Fa a deciding the wage rate. Strong and power Se ee Securing higher wages for their members. Higeee ence the wage rate in the ee ase in cost ae Hs Rotate Hd eed not be cost increasing. Higher OL imo ed productivity of of higher ae tant rroct the cost. The burden of hae caren gher yy, | onsumers in the for b M of high 8, "aher 9 at Econ tor influ ed sector i ng in an nore rganis' Bei too. result weve! totes HOWE ET Os the streng! n of increas the jndustries do not af ard on the ¢ » shifted forw n a demand is highly elastic. no (id) Material Cost : Prices of materials used in producing goog, ‘7 igil a significant part of the cost. Prices of the materials 5 cons i either due to.an increase in demand for these materials or Pi i erat Vt: owing (0 national and international developments. tae oil price is an example in this context. When the prices ors i i A co 5 increase, the effect is felt throes St igho o the prices of materials especially a the he cost structure of all goods an ‘ Jeads to upward ie of cane Higher ee des tells us that the prices of Ba due to market forces or administrative ae ate, ost thus has become one of the import cisions upward movement of price ean eum product like petro} n increase In economy. AT inputs alters ¢ of production of the last two deca have gone up either Increase in material c responsible for continuous (iv) Increase in Profit margin : Firms o| eratin| Fi enjoying monopoly power (petroleum fen in ian a administered prices” with higher profit margin. Such a - ee teeth by few firms, have their impact on pee increase prices. pe al SOR TOUOEOY Oe eed higher ee j s will be compelled to raise their prices duet The desire to have a result of initial spurt in administered pics owerto do #6 bee igher profit margins by all those who have tit omes the cause for inflationary trend. (v) Other facto: rst f : Cost of production may increase when input pris ities lit go up due to searci draught or floo rN ~ natural or artificial. Natural calat making them dearer, ae affect the supplies of raw materitls! 6 because of monopolistic ¢o operating with excess capacity & produce at a higher cost ‘ompetitive market or any other = For some ti ime economi Some insi mists have di aie sist on demand pull as seetied over the exact cause of inet : ¥ blame nd push for inflati aj r inflation. The government ve cause and others i as held responsible for 4i sons an nid! ed for the cost- i i nie eee me st-push inflation, Prof Hs Johnson nde » Johnson and mai : a any others we inion th: C cot ee fe sp i Aa whether d : i factor for inflation j: “tdema ceponsible ia ation is Of No much lean: pull or cost push as ho crac! ova wi eraction of both factor: ance. Inflation cannot a by any one of them, S, though it might have been sta jnitate pxcess demand generated in ‘the economy by itself srsapply of goods and services could be inere Wwould not cause inf economy is oper ating with excess capacity ints, additional demand c: constraints, can be met withor ut affecting pri price level such conditions are unlikely to prevail therefo; iti meet increasing demand involves additional tl Production to ., . Tn p demand-pull is supported and aggrevated by eee ntiee owe inflation caused by an increase in cost due to higher wages ort 5 imilarly prices would not last long unless supported by demand-pull, Cae lation satin at constant cost. If the ane’ does not suffer from resource PRICE INDEX Price index traces the relative changes in the prices of commodities over the period. To be more specific, a price inde» weighted. average of prices of a given basket of goods in a country, during a givel é interval of time. It is a statistical device designed to help to compare ho these prices, taken as a whole, differ between. ti index helps to measure inflation. es ndices, namely, the Wholesale Price dex (CPI). These are calculated by oods available in the WPI is different There are two important types of price i Index (WPI) and the Consumer Price In selecting a fixed bundle of goods rather than all the g economy. The bundle of goods used in calculating the fom the bundle included in the calculation of the CPi. Pric + Tt continues to be the most om Orato It measures the weighted icers. ‘The WPI measures 1, The weighting pattern what is likely |. ‘The Wholesale Index Price (W Popular measure for monitoring 1" average level of prices of goods olds ei Price changes from the perspective oF he bees of the goods in WPI and CPI differs. The Wel indiewtes to happen to consumer prices in the neat future. e.Economic Environment of Busines, ( . Economic Adviser to the Sry In India the Sie a) undertook to publish for heey, India (Ministry of ai ase, 1939 = 100, from 1949. Th atthe yn ale price index We eevised from time to tite lua - ities. The WPI was 7 ee ‘ime Yi leq % conmol modities and changing weighting pattern, Ane een li ee eae as 1970-71 was introduced in January 1977, Inthe? 8 staat oa greater uniformly, the commodities were divig as, ae major groups - primary articles; aed light and lub and manufactured products. The Nase VPI series with the ae an, 1993-94 has 435 articles/items, comprising of 98 Primary artigyt items of fuel, power, light and lubricants and 318 ™anutage? products. In the WPI, the primary articles are givena weight of 29 oy fuel, power, light and lubricants a weight of 14.23 Percent 4 manufactured product a weight of 63.75 percent. ind ty The Consumer Price Index (CPI) : Itis a weighted SU Of prices the bundle of goods and services that the domestic consumers general purchases each year. The importance of different expenditures by. average household is found out by a survey. Weights are Assigned ty the different expenditure categories to reflect the importance of each in the household spending. There are at present four consumer price indices (CPI) in India, They measure the changes over time in the general level of Prices of goods and services that four different reference groups acquire, use or pay for consumption. These are compiled in terms of the general standart and guidelines set by the International Labour Organisation (ILO) for all the member countries. The four CPI are : G) The Consumer Price Index for Industrial Workers - CP (IW): The CPI (IW) measures monthly movement of retail price of various goods and services in various industrial townships The Central Gover nment employees’ wage compensation is da* twice a year based on the movement of this index. Gi) The Consumer Price Index for Urban. Non Mant! Employees - CPI (UNME) : The CPI (UNME) monitors pie res and Services in- various cities on a monthly basis: te ee le and is basically used for determining oer Indiaj nces of employees of some foreign companies WO i, insuran MSE S2CtOrS such as airlines cormmunications, ther financial services,oa 247 nfl ii) The Consumer Price Index f, : : ‘or Agricultural Labourers - CPI (AL) : The CPI (AL) is used for fixation and revision of minimum wages for agricultural labourers in different states, (iv) Consumer Price Index for R, * ‘ural Lab Tia used for fixing wages for rural isbouen (CPI-RL) : It is The above indices have different commodity composition and weights to the various commodities and Services while CPI-UNME is com} sled and released by Central Statistical Organisation (CSO), Ministh of Statistics and Programme Implementation, the rest three are compiled and released by Labour Bureau, Ministry of Labour, Among these, the CPI-IW is the most well known, as it is used for wage indexation in government and organised sector. The important features of price indices are given in Table 13.1. Table 13.1 : Salient Features of Price Indices Features Weights Allocated On the Basis of Consumer Expenditure Survey First : | First: | First: 1958-59 | 1958-59 | 1956-57 Latest : | Latest : | Latest : 1982-83} 2001 Weights allocated based on wholesale transactio . Base year of the} current series 2. No. of items/ commodities in basket 3. No. of centres/ 2001 120-160] 260 16 600 villages 4. Time lag of the index : mest » Frequency Mon a > 90. Source : Economic Survey, 2006 07, Pic Environment of Business (MMs ti a res of different price indices the jn, Bay es will differ. Economi 248 Onaccount of different featw rates based, 07 different indic At present four price indices - lation : namely, WPI with base year 1993 CPI-UNME with base year 1984-85, and the CPI-AL and CPLRL vi base year 1986-87 are In need of updating. The consum, wit expenditure patterns in both rural and urban areas and the structure x : economy have undergone Ss}. ignificant changes over the years ang ther js a need to shift the existing bases of these indices toa more reo year. Accordingly, several exercises are being carried out under ne directives of various technical advisory committees. le both WPI and CPI represent only a fixed set of | oduced in the economy. They do not taRE The, i ind services produced in the economy and thud : It should be noted that goods and services pr account all the goods a may not reflect all changes in price level. NATIONAL INCOME (GNP OR GDP) DEFLATOR GDP (or GNP) deflator is calculated as the ratio of nominal GDP (GNP) to__ real GDP (GNP). The formula used to calculate the deflator is : GDP deflator = Nominal PP. 109 Real GDP me GDR. (or ae deflator is commonly considered implicit price deflator, é 5 pee ae a ) deflator is used as an indicator of the economy's average. ane ral erns, Nominal GDP measures current production at current price: Peco periodic eae production at constant prices (i.e. GDP at Goryeo abe de -2000 Prices). Comparing nominal GDP and rea Sent net ator and it indicates how current prices, i.e., th Price level, have changed since the base period. ie by the formula stated above, that is GDP deflator = Nominal Gop RealGbp ~*~ 100tio” minal GDP in India ; 249 if Je, the no! Ndia in 2001-02 exit? GDP in 2001-02 (i.e. at 1990, Was Rs. 2097726 cr, 1 0" peal ‘an a -2000 pri ore fon" 34, ai Rs. 2097726 app deflator = RS 71972606 * 100 = 106.34 ._ implies that the average price leve] in | Tse nt from 1999-2000 to 2001-02. 63 in the GDP deflator from one year chine measure of the inflation rate. the economy has increased by If we calculate the Percentage to the next, it will Provide us d with a ts The GDP (or GNP) deflator has two important uses : Price level indicator : The GDP (or GNP) deflator can be used as an indicator of the price level and economic activity. It can be used to measure the rate of inflation. While the inflation rate measured on the basis of CPI or WPI is more reported, €conomists prefer inflation Tate based on GDP (or GNP) deflator. This is because GDP (or GNP) deflator shows the changes in the price level of all commodities while CPI or WPI shows the changes in the Price level of a bundle of commodities. Thus, GDP (or GNP) deflator helps to capture the rate of inflation since it is not limited to a smaller subset of goods. Deflating nominal to real : GDP deflator can be used as a method of deflating nominal economic indicators to real terms. For instance if we divide nominal GDP by the GDP deflator and multiplying it by 100 would give us the real GDP. This can help to eliminate any inflationary increases in nominal values. ce, sity [ON IN INDIA hk iit a f cbeing be Stability is an essential condition for economic growth and je ‘being hee People. Price fluctuations create uncertainties in the economy "ot conducive for economic development. bation Sieg j i riable in India n is one of the most closely monitored eeotortle TS thas Considerable impact on the average conse ieee I ty Upward movement in the general prices of ane a Me hs eae ipsied as the Percentage rate of change in a price ten re uspally Petiod. The variations in prices an