INFLATION

Inflation indicates the increase in price level of goods & services and decrease in money value

CONCEPTS

INFLATION
GENERAL PRICE LEVELS INCREASES VALUE OF MONEY (PURCHASING POWER OF MONEY ) FALLS MONEY CIRCULATION IS MORE THAN PRODUCTION

PROBLEMS
PRICE RISE IS FASTER THAN INCOME
STANDARD OF LIVING DECLINES MAJOR SOCIAL TENSIONS

Different Inflations

Creeping Inflation: When the rise in prices is very slow. Less than 3% inflation p.a. is coming under this category. It is safe & essential for economic growth. Walking Inflation: When prices rise moderate and it is more than 3% and less than 10%. It is a warning signal for the govt. to control at this level. Running Inflation: When prices rise rapidly like running at a rate of 10% to 20% p.a. Strong monetary & fiscal measures required to control this. Hyperinflation: When price rises very fast from more than 20% to 100% p.a. or more. It is also called as runaway or galloping inflation.

Demand-Pull Inflation

It is described by too much money chasing few goods. Inflationary rise in prices caused by an excess of aggregate demand over aggregate supply. As per Quantity Theory of Money given full employment level of output, doubling the money supply will double the price level. Aggregate supply is assumed to be fixed due to full employment level of output, when money supply increases it creates more demand but supply cant be increased due to full employment of resources, this lead to rise in prices.

Demand-Pull Inflation

Modern Quantity theorist led by Friedman the higher the growth rate of the nominal money supply, the higher the rate of inflation. When money supply increases, people spend more in relation to the available supply. Modern Quantity theorists without assuming full employment proved price rises.

Keynesian Theory of Demand-Pull Inflation

So long as there are unemployed resources in the economy, an increase in investment expenditure will lead to increase in employment, income & output. Once full employment reached, further increase in expenditure will lead to excess demand and leading to inflation.

S1

Price level

P1

E1

P S

E D YF

D1

Demand & Supply

Cost-Push Inflation

Cost-push inflation is caused by wage increases enforced by unions and profit increases by employers. Cost-push inflation is caused by wage-push and profit-push to prices for the following reasons.

Price level

E1 P1 S2 P E D Y1 YF

Rise in the wages Sectoral rise in prices Rise in prices of Imported Raw Materials Profit-push Inflation

S1

Demand & Supply

CAUSES OF INFLATION

When the aggregate demand exceeds the aggregate supply that leads to inflations Factors Affecting increase in Demand

Increase in money supply Increase in disposable income Increase in Public expenditure Increasing in consumer spending Cheap Monetary Policy Deficit Financing Expansion of Private Sector Black Money Repayment of Public Debt Increase in Exports

CAUSES OF INFLATION

Factors Affecting shortage in Supply

Shortage of factors of production Industrial Disputes Natural calamities Artificial scarcities or Hoarding Increase in exports Lop-sided production Law of diminishing returns International Factors War

Measures to Control Inflation

1. Monetary Measures

2. Fiscal Measures Reduction in unnecessary expenditure

3. Other Measures To increase production Rational wage policy Price control Rationing

Credit Control Demonetisation of Currency Issue of New Currency

Increase in Taxes
Increase in savings Surplus budgets Public debt

Effects of Inflation

Effects on Redistribution of Income and Wealth

Debtors & creditors Salaried person Wage earners Fixed income group Equity holders & investors Businessmen Agriculture Government

Effects of Inflation

Effects on Production

Misallocation of resources Changes in the system of transaction Reduction in production Fall in quality Hoarding & black-marketing Reduction in saving Hinders foreign capital Encourages speculation

Effects of Inflation

Other Effects

Government Balance of payments Exchange rate Collapse of monetary system Social Political

EFFECTS OF INFLATION
BENEFITS

LOOSERS

DEBTORS ENTREPRENEURS INVESTORS FARMERS UPPER INCOME GROUPS

CREDITORS FIXED INCOME GROUPS CONSUMERS MIDDLE AND LOWER INCOME GROUPS