Inflation and Control Measures

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Inflation - Definition
⚫ Rise in general price level

⚫ Decline in the purchasing power of the money

⚫ Inflation is a state in which value of money is falling ie.

Prices are rising. – Prof. Crowther

⚫ Expansion in the supply of money relatively to the supply of

things to purchase – J M Keynes

⚫ Excess demand over capacity to supply

⚫ Too much of money chasing too little goods.

Types of Inflation )

⚫ Demand Pull Inflation

⚫ Cost Push Inflation

 Demand Pull Inflation
⚫ Excess of demand over available consumer goods and services
is termed as demand pull inflation
⚫ Aggregate demand for goods exceeds their supply

⚫ Causes.
✔ due to expansion in the supply of money
✔ Increase in government expenditure for economic
development
✔ Use of resources for expanding capital goods for consumer
goods industries
✔ Hoarding, Black marketing
✔ Expansion of exports cause scarcity of goods for domestic use
How demand-pull inflation occurs

⚫ If aggregate demand is rising at 4%, but productive

capacity is only rising at 2.5%; firms will see demand
outstripping supply. Therefore, they respond by
increasing prices.
⚫ Also, as firms produce more, they employ more
workers, creating a rise in employment and fall in
unemployment. This increased demand for workers
puts upward pressure on wages, leading to wage-push
inflation. Higher wages increase the disposable income
of workers leading to a rise in consumer spending.
Effects of demand-pull inflation

⚫ Lower interest rates. A cut in interest rates causes a rise in

consumer spending and higher investment. This boost to
demand causes a rise in AD and inflationary pressures.
⚫ The rise in house prices. Rising house prices create a
positive wealth effect and boost consumer spending. This
leads to a rise in economic growth.
⚫ Rising real wages. For example, unions bargaining for
higher wage rates.
⚫ Devaluation. Devaluation in the exchange rate increases
domestic demand (exports cheaper, imports more
expensive). Devaluation will also cause cost-push inflation
(imports more expensive)
 Cost Push Inflation
⚫ Cost-push inflation occurs when we experience rising
prices due to higher costs of production and higher costs of
raw materials. Cost-push inflation is determined by
supply-side factors, such as higher wages and higher oil
prices.
⚫ Inflation caused on account of increase in cost of
production is known as cost push inflation.
⚫ Cost-push inflation can lead to lower economic growth and
often causes a fall in living standards, though it often
proves to be temporary.
⚫ Cost-push inflation could be caused by a rise in oil prices
or other raw materials. Imported inflation could occur after
a depreciation in the exchange rate which increases the
price of imported goods.
⚫ Higher Price of Commodities. A rise in the price of oil would lead to
higher petrol prices and higher transport costs. All firms would see
some rise in costs. As the most important commodity, higher oil prices
often lead to cost-push inflation (e.g. 1970s, 2008, 2010-11)
⚫ Imported Inflation. A devaluation will increase the domestic price of
imports. Therefore, after a devaluation, we often get an increase in
inflation due to rising cost of imports.
⚫ Higher Wages. Wages are one of the main costs facing firms. Rising
wages will push up prices as firms have to pay higher costs (higher
wages may also cause rising demand)
⚫ Higher Taxes. Higher VAT and Excise duties will increase the prices
of goods. This price increase will be a temporary increase.
⚫ Profit-push inflation. If firms gain increased monopoly power, they
are in a position to push up prices to make more profit
⚫ Higher Food Prices. In western economies, food is a smaller % of
overall spending, but in developing countries, it plays a bigger role.
(food inflation)
Phillips Curve
⚫ The Phillips curve is an economic concept developed
by
A.W. Phillips stating that inflation and unemployment
have a stable and inverse relationship.
⚫ The theory claims that with economic growth comes
inflation, which in turn should lead to more jobs and
less unemployment
Causes of Inflation

⚫ Demand Accelerators -Factors causing an increase in

demand

⚫ Supply Constraints- Factors causing decrease in

supply

⚫ Monetary and Fiscal factors

1.Factors Causing Increase in Demand

Increase in Public expenditure

Increase in public expenditure by development planning etc increases demand of
goods and services and finally result in increased price.

Increase in Private expenditure

When business conditions are good private entrepreneurs start investing more and
more funds in new business leading to increase in the demand for the service of
factors of production. The result is increase in price

Rise in Employment and Income

Both income and employment has increased over the periods in public and private
sector results in price increase
Contd…
Increase in exports
When more goods are exported, less would be available for domestic
consumption thus leading to inflation as demand is more and availability
of goods is less.
Reduction in taxation
When government reduces tax it results to an increase in purchasing power of the
public and then it is in position to demand more goods for private consumption
thus resulting in increased price

Repayment of past internal debts

When government repays its past debts to public it results in an increase of
purchasing power of public which leads to greater demand and ultimately a rise
in price giving rise to inflation.

Rapid growth of population

Gov. expenditure at all level to provide basic amenities increases.
 2.Factors Causing Decrease in Supply

Shortage of supplies- factors of production

When there is shortage of factors of production, there occurs reduction in
the production of goods for consumption thus resulting in inflation as the
demand is high and supply is less

Hoarding of essential goods

During inflation the traders will hoard essential commodities for profit
purposes thus leading to scarcity of goods.
Erratic agriculture output
When agriculture output declines, prices rise.
Agriculture price policy of the Gov.
support price, procurement price and issue price may contribute to
inflationary rise
Inadequate growth of industrial sectors
inadequate production
Increasing administered prices
electricity, fertilizers ,gas etc
Restrictions on imports
import constrains of consumer goods has operated in supply side
3.Monetary and Fiscal Factors
⚫ Rising level of Government spending
⚫ Deficit Financing
Effects of Inflation/Consequences of
Inflation
⚫ On investing class
⚫ On producer class
⚫ On labour class
⚫ On consumer class
⚫ On debtors and creditors
⚫ Increase in taxes
⚫ Increase in public debts
⚫ Increase in employment
⚫ Increase in import and decrease in export
⚫ Development of banking
⚫ Bad effects on savings
⚫ Increase in Income
 On investing class

⚫ Divided into 2 classes

Class receiving fixed income

These get interest from their investments or income at fixed rate
whereas due to increase in prices of goods their real income
decreases
Eg. People who buy debentures, securities, fixed deposits

Class receiving varying income

These include people who buy shares of joint stock companies.
When prices increase the profit of such companies increase as a
result the shareholders also get increase profit.
They benefit from inflation
On producer class On labour class

⚫ Due to inflation the income ⚫ Gain :Inflation causes

of people increase and so increase production leading
also their purchasing power. to increased employment.

⚫ They demand for more

goods. ⚫ Loss :Their income/wage do
not increase in the ratio of
⚫ Leading to increase in rise in price.
production which earns
profit for producer class.

⚫ Eg. Traders, farmers, mine

owners
On consumer class
⚫ Divided into 2 parts

Class receiving fixed income

Sufferer of inflation.
Due to increase in price consumption of goods needs to be
reduced by this class.

Class receiving varying income

They gain to some extent, because during inflation their
income increases and their prior consumption level is
maintained even when price has increased
But they also lose as their income does not increase at the
same speed as increase in price
 On debtors On creditors

⚫ Gainers of inflation ⚫ Losers of inflation

⚫ Borrowed when ⚫ They receive less amount

purchasing power of in return as purchasing
money was high power of money has
reduced

⚫ When repaying they pay

when the purchasing
power of money is low.
 Increase in taxes Increase in public debt

⚫ To reduce the excess ⚫ To manage budget deficit

money in circulation government borrows loan
government may introduce from public.
new taxes and increase
rates of existing taxes. ⚫ These borrowings
decrease purchasing
⚫ This causes difficulty to power of public to an
public as their income is extent.
decreased.
Increase in employment Development of banking

⚫ New industries and ⚫ During inflation income of

businesses are established people and profit of
during inflation businesses increase

⚫ It leads to increase ⚫ Banks get more deposits

employment. and more chances of
issuing loans

⚫ Thus banks open branches

in other parts leading to its
development
 Increase in imports Decrease of exports

⚫ Prices of goods within ⚫ Reduction of exports due

country increases to high price of goods

⚫ Demand for foreign goods

⚫ Leading to increased
imports

Results in adverse BOP

 Bad effect on savings Increase in income

⚫ Due to fall in value of ⚫ Due to increase

money public prefer to employment and
spent its income than save development of business
it. the per capita income of
public increases
⚫ Money saved today will
have less value tomorrow.
Measures to Check Inflation )

⚫ Monetary Measures
⚫ Fiscal Measures
⚫ Other Measure
⚫ Control over Investments
⚫ Increases in Output/ Increase Production
⚫ Increased Imports
⚫ Public Distribution System
⚫ Rational Wage policy
⚫ Price Control
⚫ Rationing
Other Types of Inflation
1. Under production inflation
2. Inflation through devaluation
3. Deficit induced inflation
4. Sectorial demand shift inflation
5. Stagflation
6. Open inflation
7. Suppressed inflation
8. Creeping inflation
9. Walking or trotting inflation
10. Running inflation
11. Galloping inflation
12. Hyper inflation
1. Under Production Inflation

⚫ Occurs due to less production.

⚫ Demand for products increases or remains at same level

for a period and does not change on account of decreased
production leading to under production inflation

⚫ Due to strikes, monsoons, floods and lockouts.

2. Inflation through devaluation

⚫ Occurs when country adopts policy of devaluation of

currency in terms of other foreign currencies.

⚫ This makes import expensive an export cheaper.

⚫ Export is encouraged leading to scarcity of goods and

increase in price.
 3. Deficit Induced Inflation

⚫ Caused when government tries to recoup the deficit

existing in the budget by imposing taxes on
commodities.

⚫ This leads to increase in price of the commodity

leading to inflation
4. Sectoral Demand Shift Inflation

⚫ Sometimes increase in demand may be confined to

some sectors of the economy and not to all sectors

⚫ Thus rise in demand and increase in price of goods in

one sector will influence prices of other sectors

⚫ This type of inflation is called as Sectoral Demand

shift inflation
5. Stagflation

⚫ Stagflation refers to an economy that is experiencing a

simultaneous increase in inflation and stagnation of
economic output. Stagflation was first recognized
during the 1970's, where many developed economies
experienced rapid inflation and high unemployment as
a result of an oil shock.
⚫ Stagflation or recession-inflation is a situation in
which the inflation rate is high, the economic growth
rate slows, and unemployment remains steadily high. It
presents a dilemma for economic policy, since actions
intended to lower inflation may exacerbate
unemployment.
6. Open Inflation

⚫ Inflation is open when

⚫ Markets for goods or factors of production are allowed to
function freely, setting prices of goods and factors
without interferences by authorities

⚫ There are no checks or controls on distribution of

commodities by the government

⚫ Unchecked Open inflation may lead to hyper inflation

7. Suppressed Inflation
⚫ When government imposes fiscal and monetary controls to
check open inflation it is known as repressed or suppressed
inflation.

⚫ Market mechanism is not allowed to function normally

using licensing price control and rationing so as to suppress
extensive rise in prices.

⚫ Negative effects of this

⚫ Leads to black marketing, corruption, hoarding etc.
⚫ Misallocation of resources from essential to non
essential industries
⚫ Higher unemployment
8. Creeping Inflation

⚫ Rise in price is very slow like that of snail or creeper.

⚫ The rate of rise in price is less than 3% per annum.

⚫ It is safe and essential for economic growth

9. Walking or trotting Inflation

⚫ Prices rise moderately and annual inflation rate is a

single digit.

⚫ Rate of rise in price is in intermediate range of 3- 7 %

per annum or less then 10%

⚫ It is a warning signal to government to take necessary

steps
10. Running Inflation

⚫ Prices rise rapidly like the running of a horse at the rate

of speed of 10 to 20 percent per annum.

⚫ It affects the poor and middle class

11.Galloping Inflation
⚫ Very high rate of inflation
⚫ Double digit
12. Hyper Inflation

⚫ A situation where rate of inflation becomes

immeasurable and absolutely uncontrollable

⚫ Prices rise very fast at double or triple digits form.

⚫ Price may rise many times every day

⚫ Also called as runaway or galloping inflation

Policy Measures to Control Inflation
⚫ Monetary Measures
⚫ Fiscal Measures
⚫ Control over Investment
⚫ Increase in out put
⚫ Increased Imports
⚫ Public Distribution System
Measurement of Inflation

⚫ Inflation can be described as the general rise in the

price of goods and services in an economy over
time. It’s calculated by tracking the increase in
prices of essentials. The primary index that tracks
the change in retail prices of essential goods and
services consumed by Indian households is the
Consumer Price Index or CPI.
⚫ In India retail inflation was measured using WPI
till April 2014, and was changed to CPI.
GNP Deflator
⚫ The GNP deflator is the ratio of nominal GNP in a
year to the real GNP of that year
⚫ GNP deflator = Nominal GNP / Real GNP
⚫ Percentage change in GNP deflator between any two
continuous year gives the rate of inflation.
 WPI
⚫ Wholesale Price Index (WPI) represents the price of goods
at a wholesale stage i.e. goods that are sold in bulk and
traded between organizations instead of consumers

⚫ Inflation rate is the difference between WPI calculated at

the beginning and the end of a year.

⚫ The percentage increase in WPI over a year gives the rate of

inflation for that year.
⚫ The WPI measures the price of a representative basket of
wholesale goods.
⚫ In India, wholesale price index is divided into three
groups: Fuel and Power (13.2 percent), Primary Articles
(22.6 percent of total weight) and Manufactured Products
(64.2 percent).
⚫ Food Articles from the Primary Articles Group account for
15.2 percent of the total weight.
⚫ The most important components of the Manufactured
Products Group are Basic Metals (9.7 percent of total
weight); Food products (9.1 percent); Chemicals and
Chemical products (6.5 percent) and Textiles (4.9 percent).
CPI
⚫ Currently, CPI in India is calculated by taking a
basket of 299 commodities as compared to 676
commodities in WPI. Basically, CPI is calculated by
considering the retail price change of goods and
services and by taking the average weighted value of
each item in the basket.
⚫ The consumer price index replaced the wholesale price
index (WPI) as a main measure of inflation.
⚫ The base year of CPI was changed to 2012 from 2010.
Base year for WPI and IIP (Index of Industrial
Production) was also changed to 2012 in April
⚫ In India, the most important category in the consumer
price index is Food and beverages (45.86 percent of
total weight), of which Cereals and products (9.67
percent), Milk and products (6.61 percent), Vegetables
(6.04 percent), Prepared meals, snacks, sweets, etc.
(5.55 percent), Meat and fish (3.61 percent), and Oils
and fats (3.56 percent). Miscellaneous accounts for
28.32 percent, of which Transport and communication
(8.59 percent), health (5.89 percent), and education
(4.46 percent). Housing accounts for 10.07 percent;
Fuel and light for 6.84 percent; Clothing and footwear
for 6.53 percent; and Pan, tobacco and intoxicants for
2.38 percent.
WPI Vs CPI
⚫ “There are two layers between the wholesale price and
retail price, one is the additional cost of transportation from
the wholesale to the point of sale, and the other is the retail
mark-up.
⚫ During the lockdown, for instance, it was more difficult to
transport goods, and that additional cost got added to
individual prices," . Similarly, if there is scarcity, the retail
margin goes up, adding to the price.
⚫ Another difference between the two indices is that the
wholesale market is only for goods, you cannot buy
services on a wholesale basis. So WPI does not include
services, whereas the retail price index does. “The pricing
norms of wholesale and retail are also different.
View of India’s inflation rate
DEFLATION

Deflation is defined as a persistent fall in the average

level of prices in the economy.

⚫ Deflation is the result of reduction in the real level of

activity in an economy. It is a state in which the prices
persistently falls and thus the value of money
increases.

There are two broad explanations for a fall in the price

level, and economists have used these to categorize
“good deflation” and “bad deflation”.
 Deflation is generally seen negatively, as it suggests a fall in
aggregate demand leading to a fall in the average price
levels; which further results in an increase in unemployment.

Alternatively, deflation can also be caused by increased

productivity of firms, which increases the supply without a
linear increase in demand.

If the supply goes up, but demand remains fairly constant,

the average price level will decrease, to reach equilibrium
where demand = supply.
 Causes of Deflation

As business and consumer confidence in the economy

declines, AD falls, resulting in recession.
Causes for deflation :

Decreasing Money Supply

Increasing Supply of Goods

Decreasing Demand for Goods

Increasing Demand for Money

 Cost of deflation
⚫ Although as consumers we might be pleased to face falling
prices, a significant number of problems can be associated
with a fall in the price level. In fact, economists might
argue that the costs of deflation are greater than the costs of
inflation.

⚫ Unemployment

⚫ Effect on investment

⚫ Costs to debtors
 Useful steps to control deflation

To fight deflation, attempts must be made to raise the

volume of aggregate effective demand.

Effective demand can be increased partly by

increasing consumption expenditure and partly by
increasing investment expenditure.
⚫ 1. Reduction in Taxation:

⚫ 2. Redistribution of Income:

⚫ 3. Repayment of Public Debt:

⚫ 4. Subsidies:

⚫ 5. Public Works Programme:

⚫ 6. Deficit Financing:

⚫ 7. Reduction in Interest Rate:

⚫ 8. Credit Expansion:

⚫ 9. Foreign Trade Policy:

⚫ 10. Regulation of Production:

 Types of Deflation

⚫ Deflation by low money in the market.

⚫ Deflation by low employment

⚫ Deflation by low industrial initiative rate.

⚫ Deflation by low price then low profits in business.