Seymur M.

Guliyev
INFLATION?
Definition

 Inflation is defined as the persistent or sustained

rise of the general price level in an economy.
DEFINITION

 According to Parkin and Bade Inflation is an upward

movement in the average level of prices. Its opposite is
deflation , a downward movement in the average level
of prices. The boundary between inflation and
deflation is price stability.
 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 general price level rises,
each unit of currency buys fewer goods
and services. Consequently, inflation also
reflects an 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.
Stages of Inflation
 1. Creeping Inflation (0%-3%)

 2. Walking Inflation (3%-7%)

 3. Running Inflation (10%-20%)

 4. Hyper Inflation (20% and above)

 TYPES OF INFLATION

 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.

 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.
 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.
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.
Other Types of Inflation

Fiscal Inflation: Fiscal Inflation occurs when there is excess

government spending. This occurs when there is a deficit budget. For
instance,. America is also facing fiscal type of inflation under the
presidentship of George W. Bush due to excess spending in the
defense sector.

Hyperinflation: Hyperinflation is also known as runaway inflation

or galloping inflation. This type of inflation occurs during or soon
after a war. This can usually lead to the complete breakdown of a
country’s monetary system. However, this type of inflation is short-
lived.

To sum up, any type of inflation could affect the economy of a

country badly.
CAUSES OF INFLATION

 Inflation is caused due to several economic factors:

 When the government of a country print money in excess, prices
increase to keep up with the increase in currency, leading to inflation.
 Increase in production and labor costs, have a direct impact on the price
of the final product, resulting in inflation.
• When countries borrow money, they have to cope with the interest
burden. This interest burden results in inflation.
• High taxes on consumer products, can also lead to inflation.
• Demands pull inflation, wherein the economy demands more goods and
services than what is produced.
• Cost push inflation or supply shock inflation, wherein non availability of
a commodity would lead to increase in prices
Hyperinflation is defined as inflation that exceeds 50 percent per
month, which is just over 1percent a day.

Costs such as shoe-leather and menu costs are much worse with
hyperinflation—and tax systems are grossly distorted. Eventually,
when costs become too great with hyperinflation, the money loses its
role as store of value, unit of account and medium of exchange.
Bartering or using commodity money becomes prevalent.
The Fisher Equation illuminates the distinction between
the real and nominal rate of interest.

Fisher Equation: i = r + p
The one-to-one relationship
between the inflation rate and the nominal
interest rate is
the Fisher effect.

Actual (Market)
nominal rate of Real rate Inflation
interest of interest

It shows that the nominal interest can change for two reasons: because
the real interest rate changes or because the inflation rate changes.
 Measures to Control Inflation

 Given that inflation shows the imbalance between supply and

demand of goods at current prices so that measures be taken to
reduce demand or increase supply of goods and services.
The supply side Measures
 Increased Production
The supply of goods and services can be increased by increasing
agricultural and industrial production. Agricultural production can
be increased by providing an adequate supply of agricultural inputs
at low prices, the modernization of agriculture and scientific farm
management, adequate water supply for irrigation, industrial
production etc similarly can be increased by increased foreign
direct investment, industrial credit growth, fiscal concessions, etc.
 Control of illegal Activities
There are some illegal activities that cause significant inflation in a
country. It is hoarding, smuggling, profiteering, black markets, etc. In
the case of smuggling of large quantities of staples like sugar, butter,
wheat, rice, etc are exported abroad illegally in order to obtain higher
prices. Similarly, the shortage in most cases artificial staples to create
higher profits. All activities of this evil must be controlled through
advertising, as well as punishment.
 Peace and Security
Production and distribution of goods and services can be effected due to
the existence of disturbances and insecurity in society. In such
circumstances, investors hesitant to invest for fear of potential loss.
Similarly, the production of industrial products is affected due to
several unpleasant events such as strikes ,therefore peace and security
must be ensured to maintain the supply of goods and avoid the danger
of famine.
 Main Energy Sources
The supply of agricultural and industrial products is highly dependent on
energy availability. If the energy source is expensive, the cost of
production of goods and services will be expensive too. Increased
production costs raise prices and cause inflation. Therefore all necessary
measures be taken to provide major sources of energy in industrial and
agricultural sectors of the economy
The demand side

 Control of Money Supply

The money supply has a great influence on the rising inflation that is,
inflation with increasing the money supply and vice versa. Therefore,
to control inflation, measures must be taken to control the money
supply. The money supply can be controlled with the help of monetary
policy in which the central bank uses various methods, such as bank
rate policy, open market operations, changes in reserve requirements,
credit rationing , direct action etc. All these methods are useful to
control the rate of inflation in a country.
 Population Control
In most developing countries, the population is increasing very
quickly that the production of goods and services does not increase
at the same pace. Because the imbalance between supply and
demand of goods and services are produced and cause inflation.
Therefore, to control inflation, appropriate measures should be taken
to control the population.
 Fiscal Policy
Fiscal policy refers to government policy of public spending and
taxes. The main fiscal policy objective is to maintain only the slight
change in the general price level. During inflation, the government
tries to reduce its expenditure on unproductive activities and the
direct tax rate increases so that the purchasing power of the
population is reduced. Due to the reduction in the purchase of the
population, demand for goods and services will be reduced and
controlled inflation.
 There should be no Deficit Financing
Deficit financing shows that public spending beyond their income. The
purpose of deficit financing is to meet the additional costs that the budget
deficit. Because the money supply increases in the country and causes
inflation. Therefore the deficit financing should be discouraged and all
development costs must be met through taxes and debt.

Direct Measures
 There are several other options available to the government to control
inflation and wage and price freeze, the rationing of goods, establishment of
public service shops, the price review committees, boards of price
stabilization, etc. This direct measures are often used by the government to
control inflation.
 Deflation

 It refers to continuous fall in price level. This happens in recession period.

If it last for longer period, it harms the growth & development of the
economy.
The Government should adopt policies which are similar to the situation of
recession. Eg.
 Increase income by reducing taxes
 Generate employment
 Adopt policies which enhance production
What is Unemployment
 General Sense - Unemployment means lack of
jobs even for those who are able and willing to
work at the prevailing wage.

 Measurement point of view – the

unemployment may be defined as the gap
between the potential “full employment” and
number of employed persons.
Full employment

 Full employment is a condition of the national economy, where all or

nearly all persons willing and able to work at the prevailing wages and
working conditions are able to do so.

 Unemployment = Labor force – (no. of employed + frictionally

unemployed)
Measurement of unemployment rate

 Unemployment Rate = (Number of unemployed) ÷ labor Force

× 100
Classification of Unemployment…
Unemployment

Involuntary

Cyclical

Disguised

Structural

Seasonal

Frictional

Voluntary
 •A person is out of job
Volunt because of his own desire to
not to work on the prevalent
ary or prescribed wages.

•A person is separated from

Involu remunerative work and devoid of
wages although he is capable of
ntary earning his wages and is also
anxious to earn them.
Kinds of Unemployment
 Frictional Unemployment – defined as the no. of unemployed
persons under the condition that the no. of job vacancies equals
the no. of job seekers who somehow fail to get the job.

 It is said to exist when job vacancies equal the job seekers and
yet some persons are unemployed.

 Structural Unemployment – arises due to structural change in

dynamic economy making some workers go out of the job.
Under structural unemployment, a person either goes out of the
job or remains unemployed for prolonged period of time till he
acquires new skills.
 Contd….

 Natural Unemployment – It is the lowest rate of unemployment that

an economy can sustain over the long run. When the economy is said
to be at full employment, it is at its natural rate of unemployment.

 Cyclical Unemployment – cyclical unemployment is the result of

businesses not having enough demand for labour to employ all those
who are looking for work. When business cycles are at their peak,
cyclical unemployment will be low because total economic output is
being maximized. When economic output falls, the business cycle is
low and cyclical unemployment will rise.  
 Contd….
 Disguised unemployment: Unemployment that does not affect
aggregate output. Disguised unemployment exists where part of
the labor force is either left without work or is working in a
redundant manner where worker productivity is essentially zero.

 Underemployment: usually refers to that state in which the self

employed working people are not working according to their
capacity.

 Seasonal unemployment: Seasonal unemployment occurs at

certain seasons of the year. Refers to a situation where a number
of persons are not able to find jobs during some months of the
year.
 Contd….
Causes of Unemployment

• Open
RapidUnemployment:
Population Growth is a condition in which people have no
work to do. They are able to work and are also willing to work
• Economic Inflation
but there is no work for them.
• Economic Recession
• Changing Technology
• Demand for highly skilled labor
• Global Competition
• Illiteracy
 Over 70% of total labour force is illiterate or educated below primary level
 Agriculture – backward farming 70 % population depend on it
Effects of unemployment

 At individual level
 Mental stress
 Loss of self esteem
 Directly linked to poverty

 At social level
 Civil unrest
 Law and order problem ( naxalist , thefts etc)
 Possible Solution of
unemployment
 Frictional unemployment Solution
If unemployment benefits were reduced unemployed workers might
become more willing to work (shift the aggregate supply of labour to

the right)
Improve awareness of available jobs

 Structural Unemployment solution

Adult retraining programmes
Government gives subsidies to firms that provide training for workers
Enhance geographic mobility by building affordable housing or give
subsidies/tax breaks
Set up apprenticeship programmes to allow people to gain skills
 Contd….
 Seasonal unemployment solutions
Encourage people to take different jobs in their off season
Reduce unemployment benefits
Greater flow of information

 Disguised unemployment
Create employment opportunities in the urban areas and rural area
The Phillips Curve
 Key to understanding this trade-off is to consider the possible
inflationary effects in labour and product markets from an increase
in national income, output and employment.
 The labour market: As unemployment falls, labour
shortages may occur where skilled labour is in short supply. This
puts pressure on wages and prices to rise
 Other factor markets: Cost-push inflation can also come from
rising demand for commodities such as oil, copper and processed
manufactured goods such as steel, concrete and glass
  Product markets: Rising demand allows suppliers to lift prices
to increase their profit margins. The risk of rising prices is greatest
when demand is out-stripping supply-capacity
 The curve crosses the horizontal axis at a positive value of
unemployment. Hence it is not possible to have zero inflation
and zero unemployment
 The concave shape implies that lower the level of
unemployment higher the rate of inflation.
 Govt. should be able to use demand management policies to take
the economy to acceptable levels of inflation and
unemployment.
 In order to achieve full employment, some inflation is
unavoidable.
Long run Phillips curve:
 To keep unemployment below the natural rate, inflation must
keep on increasing every year. In the long run Philips curve will
be vertical at the rate of unemployment where real aggregate
demand equals real aggregate supply. This rate is called the
natural rate of unemployment. It is also called NAIRU or
Lowest sustainable unemployment rate (LSUR).
 The Philips Curve
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