NATURE

CAUSES &EFFECTS
DEFINITION
 Inflation means a general rise in prices
 Inflation is persistent increase in the price level rather than a
once-for-all rise in it.
 On the other hand, DEFLATION represents persistent decline
in prices
 Most of the developing countries have been suffering from
inflation in the modern days
 The developing countries have experienced 20 to 30% inflation
 The occurrence of inflation along with high rate of
unemployment is a new phenomenon and has made it difficult
to control rising prices
 CREEPING INFLATION
A small increase in the general price level
GALLOPING INFLATION
The rate of inflation in double or triple digits
HYPHER INFLATION
 When the price rise is very large and accelerating.
 It is extremely rapid &devastating
 Demand pull inflation
 Cost push inflation
 Structural inflation
 It represents a situation where the basic factor at work
is the increase in aggregate demand for output either
from the government of the entrepreneurs or the
households
Ex-In a situation of full employment, the increase in
private expenditure /the government expenditure goes
up
 It may lead to inflationary tendencies in the economy
 Inflation is caused by a situation where by the
pressure of aggregate demand for goods and services
exceeds the available supply of output(Agss)
Agss >Agdd
When aggregate demand increases for all purposes –
Consumption(C), Investment(I) and Government
Expenditure(G)- exceeds Aggregate Supply
 The supply of goods at current prices, there is a rise in
prices
 Keynes in his booklet-How To Pay For The
War?
 He explained inflation in terms of excess
demand for goods relative to the aggregate
supply of their output
 His notion of the inflationary gap which he put
forward in his booklet represented excess of
aggregate demand over full employment
output
 Thus according to him the inflationary gap leads to
rise in prices
 Keynes explained inflation in terms of demand pull
forces
 Thus the theory of demand pull inflation is associated
with the name of Keynes
 Since beyond full employment level of aggregate
supply, output cannot increase in response to increase
in demand
 This results in rise in prices under the pressure of
excess demand
 DEMAND PULL INFLATION
 Figure 16.1-hl Ahuja-Macro Economics for
Business and Management
 A rise in price reduces the real incomes of
fixed income groups, pensioners
 Cost of living increases further and people
demand for higher salaries
 Employees demand for higher
salaries/dearness allowances
 If unchecked it may lead to hyper-inflation
 Original monetary economists and the modern –
monetarists like Milton Friedman explain inflation in
terms of excess demand for goods and services.
 Keynes explained the inflation by taking the real
sector forces
 But monetarists says that excess demand comes into
being as a result of autonomous increase in
expenditure on investment or consumption
 Thus the increase in aggregate expenditure or demand
occurs independent of any increase in the supply of
money
 Monetarists say that emergence of excess
demand and the resultant rise in prices on
account of the increase in money supply in the
economy
FRIEDMAN-
 Inflation is always and everywhere a monetary
phenomenon and can be produced only by a
more rapid increase in the quantity of money
than in output
 MS>kpy----Increase in AD---- P increase
 M-Stands for quantity of money
 P-price level
 M/ P Represents real cash balances
 Y-stands for national income
 K stands for the ratio of income which people want to keep in
cash balances
 This ky represents demand for cash balances
 AD represents aggregate demand and for the aggregate
expenditure on goods and which is composed of consumption
demand(C) and investment demand(I)
 When Money ss increases , it creates excess supply of
real cash balances.
 It is expressed as Mss>kpy
 This excess supply of real money balances lead to the
rise in aggregate demand(AD)
 Then increase in AD leads to the rise in prices
 F-16.2-The effect of expansion is money supply is
split up into price rise and increase in real national
income
 It may happen if the costs, particularly the wages
costs, go on increasing
 As the level of employment increases ,the demand for
workers rises progressively so that the bargaining
position of the workers is enhanced
 To exploit this situation ,they may ask for an increase
in wage rates which are not justifiable either on
grounds of a prior rise in productivity or of cost of
lining
 The employers in a situation of high demand and
employment are more agreeable to concede to these
wage claims because they hope to pass on these rises
in costs to the consumers in the form of rise in prices

 Wage push inflation

 Cost –push inflation
 Profit-push inflation
 F-16.3 Cost Push Inflation
 It explains inflation in the developing countries in a slightly
different way
 The structuralists argue that increase in investment expenditure
and the expansion of money supply to finance it are the only
proximate and not the ultimate factors responsible for inflation
in the developing countries
 Why the aggregate food grains production has not been
sufficiently increasing in developing countries to match the
increase in demand brought about by the increase in
investment expenditure and money supply?
 Why the investment expenditure has not been
fully financed by voluntary savings and as a
result excessive deficit financing has been
made?
 This structural theory of inflation has been
explained by Myrdal &Streten in the context
of developing countries especially of Latin
America
 Agricultural Bottlenecks-inelastic Supply
 Resource Gap or Government’s Budget
Constraint-Revenue<expenditure
 Foreign Exchange Bottlenecks-Scarcity of
forex reserves
 Physical Infrastructural Bottlenecks
 Joint impact of Demand-pull and Cost Push
Factors
 Causes of inflation in developing countries
 Consumption
 Production
 Distribution
 Fiscal policy
Reducing fiscal deficit, Raising Tax Rates& Other Instruments
 Monetary Policy-Quantitative Instruments

Squeezing credit
Selective credit controls
 Supply management through imports
 Income policy

Freezing wages
 Raising average supply through fuller utilization of resources