What is inflation?
Inflation relates to the sustained rise, over a period of time, in the general price level when there is a rise in demand (for goods) without an equal rise in supply. In todays interconnected world, a lack of stability in the prices of goods and services characterizes all types of economies, be it in an emerging economy like India or in an advanced economy like the United States or underdeveloped economy like that of Senegal. But as we all know, any kind of uncertainty is not good for business; so is the case with price instability.
Explanation of causes
Since independence, the Government of Indias (GoI) expenditure has been shooting up steadily. Currently, the GoIs spends lakhs of crores of rupees every year on welfare functions (like subsidies and insurance for the poor), development works (like building roads) and administrative expenses (like salary payments). For your information, the current expenditure of the Government of India is more than Rs12,00,000 crore yes, a staggering Rs12 lakh crore! To put this in perspective, the expenditure in 1980 was just a little over Rs23,000 crore. When the government spends, it puts money into the hands of the common man, which increases her purchasing power. In short, higher spending would mean higher income, leading to higher purchasing capacity of the individual. Higher purchasing power often raises the demand for goods and services; however, in
the short run, the supply of such goods and services may not rise in equal proportion to meet the demand. This would lead to a rise in prices, a situation dubbed inflation. Also, black-marketing, hoarding, speculation, and exploding population have all contributed to a rise in demand for goods and services. It is also true that inflation might arise because of cost-push factors, like changes in production (as in the case of food grains), rise in prices of controlled-supply goods (like LPG and kerosene), and external factors like oil prices and global inflation. Yes, you could add increase in indirect tax too.
Cascading effect
By itself a rise in price of diesel wont raise the overall inflation rate. It is just one commodity among a wide range of commodities consumed by us. However, when you look at the cascading impact of the rise in price of diesel, you will know that it straight way impacts you too! It is like this: a rise in price of diesel will force the transporters to increase freight cost. Now vegetable / grain vendors use trucks to transport large quantities of their stocks to the market; this would mean that rising freight cost would add to the price they charge from the retailer / consumer. This means that we will have to pay more to buy the same old stuff! Take another example, this time on indirect tax (a favourite tool of the government to increase its tax revenues). You must have heard of Service Tax (ST) and Value Added Tax (VAT), which the government imposes on a range of services, including on restaurants. Let us say, you go down to your favourite restaurant to gorge on the delicious buffet spread. Now the bill arrives, and you notice that the final bill includes items like ST and VAT! (No, no, you didnt order for these items but the government did!) All these taxes will add up to a substantial part of your food bill and thats how indirect tax lead to inflationary situation.
What does it mean if todays newspaper says that the current inflation rate is 10%?
If a newspaper story title screams that the inflation rate is 10%, then it means that the prices, on an average of a basket of commodities (like those in the WPI oil, rice, wheat), have gone up by 10% over the prices that prevailed exactly on that date last year. (Its actually calculated on a fortnight basis; however for simplicitys sake, we took this approach.) Confused? Lets simplify. Let us say, on July 22 last year, you spent Rs100 to buy a basket of commodities. If the inflation rate today is 10%, it means that the price of that basket of commodities would have gone by 10%, to Rs110, today, i.e. on July 22 this year. It also means that the purchasing value of your Rs100 has gone down by 10%. Forget the Indian middle class; rising inflation has pushed more than one crore households, which would mean a minimum of 6 crore people, into poverty. It has the debilitating impact of depriving people of nourishment. Such deprivation affects the poor and the marginalised the most. It is no secret that more than 65% of all Indian children and 52% of all Indian women are malnourished; rising prices have only added to their woes.