INTRODUCTION

Price level is an important economic indicator as it shows the balance between real and monetary sectors and also the economic pulse of a nation in general Price index numbers are the indicators desired to measure the price level. Some of the price index numbers are used to deflate wages to reveal the real wages.

 A price level is a hypothetical measure of overall prices for some set of goods and services, in a given region during a given interval, normalized relative to some base set. Typically, a price level is approximated with a price index The average of current prices across the entire spectrum of goods and services produced in the economy. In a more general sense, price level refers to any static picture of the price of a given good, service or tradable security Price levels may be given in small ranges, such as with securities prices or presented as a discrete value.

Price levels are one of the most watched economic indicators in the world; it is widely believed that prices should stay relatively stable from year to year so as not to cause undue inflation (rising prices). If price levels begin to rise too quickly, central bankers or governments will look to decrease the money supply or otherwise decrease the aggregate demand for goods and services.

Given a set C, of goods and services, the total value of transactions in C at time t is:-

where represents the quantity of c at time t

represents the prevailing price of c at time t p'c,t represents the real price of c at time t Pt is the price level at time t

 Today the primary tool for controlling inflation is monetary policy. Most central banks are tasked with keeping the federal funds lending rate at a low level, normally to a target rate around 2% to 3% per annum, and within a targeted low inflation range, somewhere from about 2% to 6% per annum. There are a number of methods that have been suggested to control inflation. Central banks such as the RBI Federal Reserve can affect inflation to a significant extent through setting interest rates and through other operations. High interest rates and slow growth of the money supply are the traditional ways through which central banks fight or prevent inflation, though they have different approaches. For instance, some follow a symmetrical inflation target while others only control inflation when it rises above a target, whether express or implied

EXAMPLE PL

Suppose for example the Consumer Price Index (CPI) for the base year is 100 and the CPI for the next year is 110. Suppose a workers salary was Rs.5000 p.m. in the base year and the employer increased it toRs.5500p.m. in the next year. Then the real wages for the next year(call it the current year) is Real wages for Current Year in Rs. 100 =(wages of rupees in current year) X -------------------------------------------------------------------CPI for Current Year 100 X -------------110

= 5500

=5,000. Thus, in real terms, the workers wages have remained the same, despite an increase in the monetary wages. This is because although the wages rose by 10%, the prices also rose by 10%.

 In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time The term "inflation" once referred to increases in the money supply (monetary inflation); however, economic debates about the relationship between money supply and price levels have led to its primary use today in describing price inflation Inflation can also be described as a decline in the real value of moneya loss of purchasing power in the medium of exchange which is also the monetary unit of account. When the general price level rises, each unit of currency buys fewer goods and services. A chief measure of price inflation is the inflation rate, which is the percentage change in a price index over time Inflation can cause adverse effects on the economy

If, indeed, a price-level component could be distinguished, then it would be possible to measure the difference in overall prices between to regions or intervals. For example, the inflation rate could be measured as

and real economic growth or contraction could be distinguished from mere price changes by deflating GDP or some other measure.

 Economists standard answer is that the central bank controls the inflation rate through its ability to control the money supply. In particular, if output grows at percent per year and the money supply grows at percent per year, then, at least over sufficiently long periods of time, prices will grow at () percent per year. Simply, the inflation rate is determined by the change in the relative scarcities of money and goods. How much money a household wants to hold today depends crucially on that households beliefs about future inflation. As it turns out, this dependence of current money demand on beliefs about future inflation creates the possibility of a large number of equilibrium paths of inflation rates, besides the one in which prices grow at () percent. Thus, control of the money supply alone is not sufficient to pin down the time path of the inflation rate.

Cost-of-living indices (COLI) are indices similar to the CPI which are often used to adjust fixed incomes and contractual incomes to maintain the real value of those incomes. Producer price indices (PPIs) which measures average changes in prices received by domestic producers for their output. This differs from the CPI in that price subsidization, profits, and taxes may cause the amount received by the producer to differ from what the consumer paid. There is also typically a delay between an increase in the PPI and any eventual increase in the CPI. Producer price index measures the pressure being put on producers by the costs of their raw materials. This could be "passed on" to consumers, or it could be absorbed by profits, or offset by increasing productivity. In India and the United States, an earlier version of the PPI was called the Wholesale Price Index. Commodity price indices, which measure the price of a selection of commodities. In the present commodity price indices are weighted by the relative importance of the components to the "all in" cost of an employee. Core price indices: because food and oil prices can change quickly due to changes in supply and demand conditions in the food and oil markets, it can be difficult to detect the long run trend in price levels when those prices are included. Therefore most statistical agencies also report a measure of 'core inflation', which removes the most volatile components (such as food and oil) from a broad price index like the CPI. Because core inflation is less affected by short run supply and demand conditions in specific markets, central banks rely on it to better measure the inflationary impact of current monetary policy.

There is broad agreement among economists that in the long run, inflation is essentially a monetary phenomenon. However, in the short and medium term inflation may be affected by supply and demand pressures in the economy, and influenced by the relative elasticity of wages, prices and interest rates. The question of whether the short-term effects last long enough to be important is the central topic of debate between monetarist and Keynesian schools. In monetarism prices and wages adjust quickly enough to make other factors merely marginal behavior on a general trendline. In the Keynesian view, prices and wages adjust at different rates, and these differences have enough effects on real output to be "long term" in the view of people in an economy. A great deal of economic literature concerns the question of what causes inflation and what effect it has. There are different schools of thought as to what causes inflation. Most can be divided into two broad areas: quality theories of inflation and quantity theories of inflation. Many theories of inflation combine the two. The quality theory of inflation rests on the expectation of a seller accepting currency to be able to exchange that currency at a later time for goods that are desirable as a buyer. The quantity theory of inflation rests on the equation of the money supply, its velocity, and exchanges. Adam Smith and David Hume proposed a quantity theory of inflation for money, and a quality theory of inflation for production

TYPES OF INFLATION
Three types of inflation Demand-pull inflation Cost-push inflation Built-in inflation

 Indias 2008 Economic Survey Report targeted a drop in Indias Inflation Rate but with food, oil and commodity price rises worldwide, the opposite is happening. Indeed, by July 2008, the key Indian Inflation Rate, the Wholesale Price Index, has risen above 11%, its highest rate in 13 years. This is more than 6% higher than a year earlier and almost three times the RBIs target of 4.1%. Inflation has climbed steadily during the year, reaching 8.75% at the end of May. There was an alarming increase in June, when the figure jumped to 11%. This was driven in part by a reduction in government fuel subsidies, which have lifted gasoline prices by an average 10%. The Indian method for calculating inflation, the Wholesale Price Index, is different to the rest of world. Each week, the wholesale price of a set of 435 goods is calculated by the Indian Government. Since these are wholesale prices, the actual prices paid by consumers are far higher.

 Consumers are unlikely to get any relief from high food prices, even though the wholesale price index (WPI)-based inflation has touched a six-year low of 2.43 per cent. The food-price segment in the WPI has been growing at 8.3 per cent, much higher than the rise in the index for manufactured articles. In fact, segments like minerals and fuel have witnessed a decline in the WPI and have pulled the inflation down. The rise in food prices affects the common man more than the increase in prices of any other item. The spurt at the retail level for a variety of products is even sharper. The rise in retail prices of everyday food items like rice, sugar, pulses and tea is up in the range of 22-47 per cent over the yearago prices, while items like wheat have stabilized

The Reserve Bank of India defines the monetary aggregates as Reserve Money (M0): Currency in circulation + Bankers deposits with the RBI + Other deposits with the RBI = Net RBI credit to the Government + RBI credit to the commercial sector + RBIs claims on banks + RBIs net foreign assets + Governments currency liabilities to the public RBIs net non-monetary liabilities. M1: Currency with the public + Deposit money of the public (Demand deposits with the banking system + Other deposits with the RBI). M2: M1 + Savings deposits with Post office savings banks. M3: M1+ Time deposits with the banking system. = Net bank credit to the Government + Bank credit to the commercial sector + Net foreign exchange assets of the banking sector + Governments currency liabilities to the public Net non-monetary liabilities of the banking sector (Other than Time Deposits) M4: M3 + All deposits with post office savings banks (excluding National Savings Certificates).

The amount of money in the economy are measured according to varying methods or principles. One such method incorporates only money that is usually used to purchase goods and services, such as cash and the contents of checking accounts. The money supply is just that: the amount of money floating around the economy and available for spending. Different numerical aggregates show different subsets of money based on their liquidity, starting with M0 (the most liquid), which is just the dollar value of physical cash and coin, and M1, which includes all of M0 as well as checking accounts, traveler's checks and demand deposits. The M2 aggregate includes the dollar value of all of M1 in addition to savings accounts, time deposits of less than Rs100,000 (such as certificates of deposit), and money market funds held by investors

The H.6 Statistical Release, Money Stock Measures, provides information and downloadable data on the various money supply measures that the Fed monitors for monetary policy purposes. The release provides data on the components of the monetary aggregates, as well as the aggregates-such as M1, M2, and M3. The release also provides statistics on the growth rates of the various money supply measures. Finally, it is important to note that policymakers actually target the federal funds rate; they only monitor the monetary aggregates

 Because money is used in virtually all economic transactions, it has a powerful effect on economic activity. An increase in the supply of money works both through lowering interest rates, which spurs investment, and through putting more money in the hands of consumers, making them feel wealthier, and thus stimulating spending. Business firms respond to increased sales by ordering more raw materials and increasing production. The spread of business activity increases the demand for labour and raises the demand for capital goods. In a buoyant economy, stock market prices rise and firms issue equity and debt. If the money supply continues to expand, prices begin to rise, especially if output growth reaches capacity limits. As the public begins to expect inflation, lenders insist on higher interest rates to offset an expected decline in purchasing power over the life of their loans. Opposite effects occur when the supply of money falls or when its rate of growth declines. Economic activity declines and either disinflation (reduced inflation) or deflation (falling prices) results.

Federal Reserve policy is the most important determinant of the money supply. The Federal Reserve affects the money supply by affecting its most important component, bank deposits. Here is how it works. The Federal Reserve requires depository institutions (commercial banks and other financial institutions) to hold as reserves a fraction of specified deposit liabilities. Depository institutions hold these reserves as cash in their vaults or Automatic Teller Machines (ATMs) and as deposits at Federal Reserve banks. In turn, the Federal Reserve controls reserves by lending money to depository institutions and changing the Federal Reserve discount rate on these loans and by open-market operations. The Federal Reserve uses open-market operations to either increase or decrease reserves. To increase reserves, the Federal Reserve buys U.S. Treasury securities by writing a check drawn on itself. The seller of the treasury security deposits the check in a bank, increasing the sellers deposit. The bank, in turn, deposits the Federal Reserve check at its district Federal Reserve bank, thus increasing its reserves. The opposite sequence occurs when the Federal Reserve sells treasury securities: the purchasers deposits fall, and, in turn, the banks reserves fall.

 If the price of a box of Corn Flakes changes from Rs.150 to Rs.200 over the course of a year, with no change in quality, then this price difference represents inflation.
To measure overall inflation, the price change of a large "basket" of representative goods and services is measured. The combined price is the sum of the weighted average prices of items in the "basket". A weighted price is calculated by multiplying the unit price of an item to the number of those items the average consumer purchases. Weighted pricing is a necessary means to measuring the impact of individual unit price changes on the economy's overall inflation. A movie ticket was for a few paisa in my dads time. Now it is worth Rs.50. My dads first salary for the month was Rs.400 and over he years it has now become Rs.75,000. This is what inflation is, the price of everything goes up. Because the price goes up, the salaries go up.

Notes and coins can be used to exchange for goods and services. After all, money is a medium of exchange. The money supply is important because it is said to give some indication of the extent to which spending will occur. If my employers give me a generous 50% pay increase, I will have more money in my pocket and I am likely to want to spend at least some of it on items that previously I might not have been able to afford.

CO IN
In times of rising inflation this also means that cost of living increases are much higher for the populace. Cooking gas prices, for example, have increased by around 20% in 2008. With most of Indias vast population living close to or below the poverty line, inflation acts as a Poor Mans Tax. This effect is amplified when food prices rise, since food represents more than half of the expenditure of this group. The dramatic increase in inflation will have both economic and political implications for the government, with an election due within the year. Economic growth in emerging markets has slowed but is far from over. With the BRIC countries (Brazil, Russia, India and China) alone accounting for more than 3 billion people, and with these people consuming more resources every year, it is likely that higher inflation rates will be with us for a good while yet and that is worrying news for the government of India.

CN MS
Monitoring the money supply can be a useful tool in understanding "the big picture" of what is going on in the economy. Towards the end of the summer/early fall of 2008, we saw money supply indicators, like MZM, contract. This was the result of deleveraging; in our debt-based economy, in which all money originates out of debt, paying off debts reduces the money supply -- while the issuance of debts increases money supply. Thus, the combination of deleveraging (paying off debts) with a decrease in bank loans resulted in the money supply contracting, the dollar strengthening, and asset prices falling -- all characteristics of deflation.