Economic Environment of Business

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Copyright: 2012-14 Group_01_Sec_B
Presented By: Misha Rawal 106 Ujjwal Gupta 107 Anurag Anwariya 108 Suveer Malhotra 109 Vipul Jain 110 Gaurav Singh - 111
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* Inflation-meaning * Types * Causes * Inflation in Indian economy * Inflation and economic growth * Inflation and unemployment * Measures to control inflation
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* An increase in the general level of prices in an economy that is sustained over a
period of time is called inflation.
* Inflation reflects erosion in the purchasing power of money. * Crowther defines inflation as a state in which the value of money is falling i.e.
prices are rising. goods.
* Coullborn says it is a phenomenon where, too much money chases too few
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On the basis of the rate of increase in price level, inflation is classified in to FOUR categories
* Creeping inflation * Running Inflation * Galloping Inflation * Hyper Inflation
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CREEPING INFLATION: Characterized by slow and predictable increase in prices. Can be defined as a single-digit annual inflation rates less than 3 percent. If the creeping inflation persists for long, where there is no monetary and fiscal control, it may lead to running inflation WALKING INFLATION: Sustained price increase from 3 to 7 or below 10 percent Not risky in itself, but indicates a sign of danger ahead .
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RUNNING INFLATION: has inflation rate between 8-10 %. A sense of urgency needs to be shown in controlling the running inflation. Persistent running inflation reduces the savings in the economy and results in slowdown in economic growth.
GALLOPING INFLATION: Inflation in double-digit figures. Monetary authorities loose control over inflation Many Latin American countries like Argentina and Brazil had inflation rates of 50 to 70 per cent per year in the 1970s and 1980s. The post world war II period of Germany witnessed hyperinflation of 140% in 1921.Many developed and industrialized countries like Italy and Japan also witnessed the hyper inflation in the past. 6 Copyright: 2012-14 Group_01_Sec_B
Inflation is either caused by:A) cost push or B) demand pull This creates a wide gap between the aggregate demand and aggregate supply. This results in the increase in the prices One difference between the demand pull and cost push inflations is the unemployment level. In demand pull inflation the unemployment level remains low, whereas in the cost push inflation the unemployment level is on rise.
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The general rise in price level is because the demand for goods and services is in excess of the available supply at existing prices. The reasons for the shift in AD curve can be either real or monetary factors. It is due to:
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The real factors The monetary factors May be caused by expansionary fiscal and monetary policies - can be cured by contractionary policies
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Real
Factors: The real factors can be increase or decrease in the tax receipts and corresponding increase or decrease in government expenditure. Other factors are investment function, consumption function. The monetary Factors: Monetary factors can be increase or decrease in the money supply. Example: In 1990s when Russian government financed its budget deficit by printing rubbles, the inflation rate per month increased to 25 percent per month and the annual inflation rate was 13.55 percent.
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explains the causes of inflation

Wage push inflation Profit push inflation Supply shock inflation
origination from the supply side. Cost push inflation depends on:
output
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Wage push inflation: Created by labor unions and workers who are often
able to increase their wages faster than their productivity
Profit push inflation: Business firms pricing the goods and services on sole
basis of their direct cost of materials and labor. In other words , aggressively motivated towards profit margin.
Profit-wage spiral:
a)
Wage push and profit push inflation go hand in hand, which ever may be the leading cause. b) Higher prices and profits induce demand for higher wages, thereby forcing unions labor to increase their wages. c) Following the wage hike, firms raise the product prices, when this process gets going, Group_01_Sec_B Copyright: 2012-14 it takes the form of profit-wage spiral. 11
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Supply shock Inflation: is generally caused by the unexpected decline in
supply of the major consumer goods or key industrial inputs.
For example: food prices shoot up due crop failure or prices of coal, oil go up because of labor strikes, natural disaster. the sudden rise in the OPEC oil prices due to 1970s Arab-Isreal War
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* If demand pull inflation is correct the government must bear the cost of excessive
spending and monetary authorities are to be blamed for cheap money policy
* On the contrary, if cost push is the real cause for inflation then the trade union
are to blamed for excessive wage claim, industries for acceding them and business firms for marking-up profits aggressively.
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* Method 1:
By computing change in price index number(PIN):
Rate of Inflation={(PIN(t)-PIN(t-1))/PIN(t-1)}*100
* Method 2:
A metric that accounts for the effect of inflation in the current years gross national product by converting its output to a level relative to a base period. GNP Deflator= (Nominal GNP)/(Real GNP)
The percentage change in GNP deflator between any two years gives a measure of inflation.
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Inflation and economic growth are parallel lines and can never meet. Inflation reduces the value of money and makes it difficult for the common people. Inflation and economic growth are incompatible . If a country experiences high ECONOMIC GROWTH i.e. higher GDP, it is likely that there would be much more demand in the economy (due to people getting richer). The higher the GDP is, the higher demand would be. Therefore, it would shift the aggregate demand curve to the right whereas short run aggregate supply can't respond immediately to the change creating INFLATION (general and sustained rise in price levels)
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* As the inflation is rising
people would not be able to spend their money on other goods other than food. So in this way the demand for other goods other than food would fall and ultimately the profit as well as revenue of all the sectors would fall due to which all private companies would start cutting their work force and thus unemployment would rise and it will ultimately affect our country GDP which is used to measure Economic growth of a country. Nevertheless, low inflation rate means slow economic growth. Whenever, money is in excess, there is bidding by the consumers due to which the cost of goods escalate.
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* In reality, low inflation rate and an upward economic growth is never possible.
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* CPI or Consumer Price Index
An index of the variation in prices paid by typical consumers for retail goods and other items. An inflationary indicator that measures the change in the cost of a fixed basket of products and services, including housing, electricity, food, and transportation. It is compared to a base year for calculation. (India = 1984-1985)
* GDP or Gross Domestic Product

Gross domestic product (GDP) is the market value of all officially recognized final goods and services produced within a country in a given period of time. GDP = Private Consumption + Gross Investment + Government Spending + (Exports Imports) $1.85 Trillion US dollars at current prices - 2011
Source: World Bank
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Investment Interest rates Exchange rates Unemployment Stocks

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Unemployment refers to a situation where a worker who is willing and capable to work is unable to get employment. Types of unemployment:
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Job leaver Lob loser New entrant
He/She is no longer unemployed if

Hired / recalled Withdraws from the labor force
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* Unemployment Rate = Total no. of unemployed workers

Total labor force
* 100
* Labor Force- The number of people employed or self-employed

plus those unemployed but ready and able to work.
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* Frictional: arises from normal labour turnover, ie people entering and leaving the
labour force.
* It is inevitable and always exist * Associated with the period of time in which people are searching for jobs * Fiscal and monetary policies can not reduce frictional unemployment macroeconomic
policies are irrelevant.
* Structural: arises due to changes in technology, international competition, etc.

* Arises due to skill obsolescence or lack of competitiveness. * Associated with wider structural or technological changes in the economy that may
make some jobs redundant.
* Lasts longer than frictional unemployment

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* Cyclical: fluctuates with the business cycle.

* Increases during a recession and falls during an expansion. * High during recessions and low during booms. * Fiscal and monetary policies can reduce cyclical unemployment policies are relevant.
* Seasonal unemployment is unemployment due to seasonal changes in

employment or labor supply.
* Ex: Student internships & workers in a construction site.
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Natural Rate of Unemployment is the rate of Unemployment when the labour market is in equilibrium. Equilibrium in the labour market is when labour demand equals labour supply. It is that rate at which there is no cyclical unemployment, i.e. all the unemployment is structural or frictional. E.g. a worker who is not able to get a job because he doesnt have the right skills Full employment occurs when the unemployment rate equals the natural rate of unemployment. It is unemployment caused by supply side factors rather than demand side factors. Example: the Natural rate of unemployment is 4%. If the govt increased AD there may be a temporary fall in unemployment but in the Long Run it would return to the natural rate of 4%.
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Workers have leverage / options
Low Unemployment
Wages rise
Rise in cost
Increased Buying power
Increased inflation
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Suggests an inverse relationship (or a trade-off) between inflation and the
unemployment rate. Named after A W Phillips who originally discovered the relationship between unemployment and nominal wages, using British data in 1950s. In general, inflation is associated with economic expansion and unemployment with economic recession. During expansion: the greater the rate of growth of AD - inflation is high unemployment is low. During recession: the slower the rate of growth of AD - inflation is low unemployment is high.
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* As inflation increases,
unemployment decreases & viceversa.
*If inflation=expected,
unemployment = natural rate.
* If inflation>expected,
unemployment<natural rate
*If inflation < expected,

unemployment>natural rate
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*The long-run Phillips curve

(LRPC)
*vertical at the natural

unemployment rate.
* intersects SRPC at expected

inflation rate.
* Shifts only if natural
unemployment rates rises or falls.
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Trade-off: a rise in inflation should lead to a decline in unemployment, and vice versa. In general, both can not be brought down to the minimum level. The society must make a choice between low inflation and low unemployment. always returns to the natural rate of unemployment, making cyclical unemployment zero and inflation equal to expected inflation. the Phillips curve would predict. Eg: Stagflation.
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The equation only holds in the short term. In the long run, unemployment
The relation between unemployment and inflation is more unstable than

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1) 2)
Planned devaluation Market-driven devaluation
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1)
Planned devaluation: -
Planned devaluations are brought about almost exclusively by government decisions to deliberately reduce the relative value of a currency, usually intended as a means to some improvement in the country's trading position.
2) Market-driven devaluation: Formal recognition by a government, frequently during a monetary crisis, that the value of its currency relative to major world currenciesespecially the dollarhas already depreciated through trading in the foreign exchange markets
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Improve trade balance
Alleviate balance of payments difficulties Expand output and employment
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Current account deficit of over 290 crores due to
five year plan second
Inflation has caused Indian prices to become much higher than world prices Budget deficit due to defense spending in 1965/1966 was 24.06% of total
expenditure.
Money supply increase Depleting foreign reserves The first was India's war with Pakistan in late 1965. The US and other countries friendly towards pakistan
withdrew foreign aid to India.
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The trade deficit in 1990 US $9.44 billion. The current account deficit was US $9.7 billion. The gulf war to higher imports due to the rise in oil prices. Cost pull inflation. Political and economical instability. Depleting foreign exchange reserves. Gold is pledged to IMF by preceding government.
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Indias economy is in Stagflation-weaker growth but inflation still stubbornly high. -Glenn Levine, Senior Economist, Moody's Analytics
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* The inflation rate in India was recorded at 7.81 percent in September of
2012.
* The most well-known measures of Inflation are the CPI- consumer price
index which measures consumer prices. wholesale price index number (WPI) proper indicator of core inflation.
* But in INDIA the decade wise annual average rate of inflation based on
* The rate of increase in the prices of non-food manufactured goods is a
* Vegetable prices have increased by 49% compared to 2011, and power and
fuel expenses have increased by 11.5%.
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* (Source: Bloomberg,)
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* Some astonishing inflation figures usually termed as galloping inflation:
Year 1966 1973 1974 1980 10.77% 16.79% 28.52% 11.38% Inflation Rate
Source: www.inflation.eu
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Source:www.tradingeconomics.com
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Inflation trend India
12 10
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6 4 2 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Inflation trend India 5.4 3.8 4.2 4.2 5.3 10.9
11.7
8.9 7.8
6.4
8.3
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Source: www.indexmundi.com
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Product groups Fuel & power Food Products Textiles Chemical & chemical products Weight(%) 14.91% 9.97% 7.33% 12.02% 2011-12 14.0 7.1 7.5 8.6 2012-13(Forecast) 9.4 10.8 1.0 7.5
Basic metals, alloys & metal products

Machinery & machine tools Transport, equipment & parts
10.75%
8.93% 5.21%
11.10
3.1 3.5
7.1
4.0 5.5
Source: Monthly Review of Indian Economy

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* Capital Stock Deficiency :Capital stock deficiency tends to lead to bottlenecks,
under which resource constraints, including limited infrastructure and/or the lack of manufacturing capacity delay overall production or service generating processes, further leading to higher inflation through shortages in supply.
* Demand Side Drivers (The Mahatma Gandhi National Rural Employment
Guarantee Act (MNREGA)):a sharp rise in personal income and an expansionary fiscal policy, have also played an important role in keeping inflation persistently high.
the lack of rainfall during the monsoon season often hits India's food production. In addition, the structural change in food intake has contributed to food price inflation. Copyright: 2012-14 Group_01_Sec_B 46
* Food Price Pressures: Food price inflation has been a major driver of inflation and
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* Inflation Expectations : In the RBI's latest inflation expectations survey of
households, respondents' inflation expectations for three months ahead inched up to 12.2 percent in the third quarter of 2011 from 11.8 percent in the second quarter.
* Import Price Pressures: Import price pressures have also been an important
factor for overall inflation as India has become a more open economy over the past 10 years.
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Countries USA 2.00%
Inflation(sept 2012)
China
Brazil South Africa Pakistan
1.90%
5.28% 5.50% 7.70%
48 Source: www.tradingeconomics.com
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* 31% of Indians rated their present and future lives as "suffering" compared to
24% in 2011. Similarly, only around 13% said that they are "thriving" compared to 21% a year ago.
the proportion rose from 15% in 2011 to 32% now.
* The biggest jump in the "suffering lot" is in the middle 20% population, where
* In case of the richest 40% the numbers went up from 10% a year ago to 22%
now, while the smallest jump was in the poorest 40% surveyed by the agency, where the increase was of the order of four percentage points this year to 38%.
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Measures by which the inflation can be controlled: Monetary measures Fiscal measures
Monetary Measures
Bank rate policy Open market operations
variable reserve ratio
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Fiscal measuresMeasures taken by the government to control inflation. A: Decrease in public expenditure- One of the main reasons of inflation is excess public expenditure like building of roads ,bridges etc. Government should drastically scale down its non essential expenditure. B:Delay in payment of old debts: Payment of old debts that fall due should be postponed for sometime so that people may not acquire extra purchasing power. C:Increase in taxes : Government should levy some new direct taxes and raise rates of old taxes. D:Over valuation of money: To control the over valuation of money it is essential to encourage imports and discourage exports
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Other measures
1)Increase in the production- major causes of the inflation is the excess of demand over supply, so those goods should be produced more whose prices are likely to rise rapidly. public sector should be expanded and private sector should be given more incentives. 2) Proper Import/ Export policy- Scarce goods should be imported and export should be discouraged. 3) Encouragement to savings Government should come out with attractive saving schemes. It may issue 5 or 10 year bonds in order to attract savings. 4) price control and rationing and wage policy: Government can fix the upper limit on the prices of goods and services
5) Government sometimes puts temporary freeze on the earnings of the workers and employees, so that the purchasing power can be curbed. Example: Government of India imposed, temporary freeze on the leave travel Concession (LTC) for its employees.
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Thank you! *
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* Creeping inflation * Running Inflation * Galloping Inflation * Hyper Inflation

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* GDP or Gross Domestic Product

Source: World Bank

Investment Interest rates Exchange rates Unemployment Stocks

Copyright: 2012-14 Group_01_Sec_B

Job leaver Lob loser New entrant

He/She is no longer unemployed if

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* Unemployment Rate = Total no. of unemployed workers

* Labor Force- The number of people employed or self-employed

Copyright: 2012-14 Group_01_Sec_B

* Structural: arises due to changes in technology, international competition, etc.

* Lasts longer than frictional unemployment

* Cyclical: fluctuates with the business cycle.

* Seasonal unemployment is unemployment due to seasonal changes in

* Ex: Student internships & workers in a construction site.

Copyright: 2012-14 Group_01_Sec_B

Copyright: 2012-14 Group_01_Sec_B

Workers have leverage / options

Increased Buying power

Suggests an inverse relationship (or a trade-off) between inflation and the

Copyright: 2012-14 Group_01_Sec_B

unemployment decreases & viceversa.

unemployment = natural rate.

*If inflation < expected,

Copyright: 2012-14 Group_01_Sec_B

*The long-run Phillips curve

*vertical at the natural

* intersects SRPC at expected

* Shifts only if natural

unemployment rates rises or falls.

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The relation between unemployment and inflation is more unstable than

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withdrew foreign aid to India.

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Basic metals, alloys & metal products

Source: Monthly Review of Indian Economy

* Demand Side Drivers (The Mahatma Gandhi National Rural Employment