INFLATION

Edited by
SATWIK DEY
 Inflation
Introduction
This unit will discuss the types of inflation, sources of inflation, methods to measure
inflation and measures to control inflation.

Objectives
Analyze the
Identify Describe relationship Determine
Explain different suitable
different between inflation
various types methods of measures to
sources of and
of inflation measuring unemployment control
inflation rate
inflation inflation
 INFLATION
An increase in the general level of prices in an
economy that is sustained over a period of time is
called inflation.
The emphasis is on the ‘general price level’ which is ‘sustained
over a period’. Therefore, increase in the price of a particular
good is not called inflation.

Inflation is measured for a basket of goods and

services.

Within the basket, prices of some

of the goods and services may rise
and prices of some of the goods
and services may fall.
When the overall price of the defined basket
increases, it is called inflation.
To be defined as inflation, the increase in the price
level of the basket of goods and services should be
sustained over a period.
Therefore, a one-shot increase in the price level of
the basket of goods and services is not defined as
inflation.
 Types of Inflation

Open Inflation: When government does not attempt to

restrict inflation
Repressed Inflation: When government prevents the
price rise through price controls, rationing, etc.

Comprehensive Inflation: When the prices of all

commodities rise in the entire economy
Sporadic Inflation: Time when prices of only a few
commodities in some regions (areas) rise
 Types of Inflation
Creeping inflation can be described as a situation where the rate of
increase in the price level is small or gradual.

Creeping inflation encourages investment in the economy.

If creeping inflation continues for a longer period of time and is not properly
controlled, it becomes running inflation.

Running inflation leads to a fall in savings in the economy and hampers

economic growth, if it is not controlled.

In running inflation, the price increase is between 8-10 percent per annum.

If monetary authorities lose control over running inflation, it becomes

galloping inflation.

Galloping inflation occurs when the inflation reaches double- or triple-digit figures.
 Measuring Inflation
Inflation can be measured through the wholesale price index
and the consumer price index.

Wholesale
price
index

The
wholesale The WPI is The non-
In India the
price index The index Office of the The weights drawn up commodity
measures helps assigned to
Economic at frequent producing
the the items
variations in policy Adviser included in the intervals, sector i.e.
makers in (OEA) in the commodity and services
the price
Ministry of basket of WPI
levels of policy Industry is series are therefore and non-
commodities formulatio based on their continuous tradable
responsible
that flow volume in monitoring commoditi
through the n and for compiling
wholesale
economic the of the price es are not
wholesale transactions in
wholesale level is covered in
trade analysis. price index.
the economy.
possible. the WPI.
intermediari
es.
 Consumer price index
The consumer price index indicates the cost of living of a particular
group in the population.

CPI is measured on the basis of the changes in retail prices of selected goods and
services on which a particular income group of consumers spend their money.

There are several consumer price indices and each index measures the retail prices of goods
consumed by different segments as the consumption patterns of different groups vary.

Each commodity is given a different weightage.

The consumption basket data is collected from family budget surveys

and the price data are obtained from retail outlets.
 The Economic Impact of Inflation

Debtors and Investors

Creditors:
The effects of inflation on
Debtors are Producers investors are based on two
benefited by inflation factors – the investor’s
as it causes a fall in investment in equity, and
Inflation benefits his investment in fixed
the value of money producers as the
they must repay in income securities. Equity
rise in the price investments generally rise
the future. The price level is, in most in value during inflation,
level increases at a cases, more than benefiting investors
higher rate than the the rise in costs. because of the increase in
interest rates. equity prices. Investments
Creditors, however, in fixed income securities
are at a disadvantage results in loss to investors
as they receive less in real terms as the real
than the amount in income from the
investment falls.
real terms.
 The Social Impact of Inflation

• Economist Keynes called inflation as one eyed

deer

• Inflation makes rich richer and poor poorer

• Inflation increases inequality of distribution of

wealth and income in society
 Inflation in AD-AS Framework

Aggregate demand (AD):

Aggregate demand is the total demand for all
goods and services produced within an
economy.
It can be described as the
relationship between the total
quantity of output that consumers
are willing and able to purchase at
various price levels in a defined
period of time.
The aggregate demand curve slopes
downward because of the real balances effect,
the foreign trade effect and the interest rate
effect.
Therefore the price effect, which is seen in the
downward slope of the demand curve, is the
combination of these three effects.
Aggregate supply (AS):
Aggregate supply is the total quantity of
output supplied at every price level in an
economy in a given time period.
The slope of the aggregate supply
curve is always positively upward.
The upward slope of the
supply curve or the positive
relationship between price
and quantity supplied can be
explained in terms of the
profit effect and the cost
effect.
Demand-pull inflation Y
Price
In the graph, the shift in the AD curve towards right indicates AS
Level
an excess demand for goods and services at existing prices.

The AD increases to Y1 from Yo because of the shift in the ADo

curve to AD1. P1

But at the price level Po, the AS is Yo. P0

AD
Therefore the excess demand is Y1-Yo.
1

To eliminate the excess demand, the price level increases to AD0

P1, where AD and AS are equal at Y2.
O X
Y0 Y2 Y1

The real factors: The real factors that The factors causing a shift in the AD
could be responsible for the can be classified into real and
rightward shift in an AD curve are – monetary factors.
an increase in the government
The monetary factors: A decrease in
expenditure with no change in tax
the demand for money or an increase
receipts, a decrease in the tax
in the supply of money causes a
receipts with no increase in
rightward shift in the AD curve.
government spending, and/or a
rightward shift in the consumption
function, investment function and/or
export function.
Cost-push inflation
Y
Price
Cost-push inflation occurs when an increase in the cost AS1
of factors of production results in decrease in the Level AS0
supply.
When AS curve shifts leftward from ASo to AS1, the price P1
level increases from Po to P1. P0
There are three types of cost-push inflation – wage-push
inflation, profit-push inflation and supply shock
inflation. AD

O Q1 Q0 X
Quantity

Wage-push inflation is a result of the increase in the money wages of the workers at a
higher rate than the increase in the productivity.

Profit-push inflation results from the increase in prices more than the increase in the cost of
production.

Supply shock inflation occurs when there is a rise in the costs of raw materials or scarcity of
it due to the natural calamities.
 Measures to Control Inflation
• Monetary measures

• Fiscal measures

• Other measures
 Monetary measures

• Monetary policy is framed by the central bank

of a country

• The central bank is required to regulate the

money supply in the economy in order to
control the rate of inflation.
 Monetary measures
• Quantitative credit control measures are in the form
of bank rate policy, open market operations and
variable reserve ratio, which influences the cost and
availability of credit in an economy. The cash reserve
ratio is the most significant monetary control
measure and a high cash reserve ratio requirement
reduces the capacity of the banks to lend.
• Qualitative or the selective control measures include
the regulation of consumer credit, directives, moral
persuasion, publicity, etc. to control monetary
expansion in the economy.
 Fiscal measures
• Public expenditure: A decrease in the public
expenditure by the government can control
the inflation rate

• Taxation: The amount of disposable income

depends on the taxation policy of the
government. The imposition of direct or
indirect taxes reduces the purchasing power
of the people
 Other measures

• Price control and rationing: Price control is a

situation where the government fixes an
upper limit on the prices of goods and services

• Wage policy: The government can undertake

certain steps like restriction of additional
benefits offered to employees