INFLATION

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INFLATION
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Contents

• What is inflation meaning
• Theories of inflation four different theories
• Control measures
• How is inflation measured
• Effects of inflation
• Examples of inflation

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INFLATION

• Inflation is nothing more than a sharp upward
  rise in price level.
• Too much money chasing, too few goods.
• Inflation is a state in which the value of money
  is falling i.e. prices are rising.

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Theories of inflation

• Demand-pull inflation
• Cost-push inflation
• Quantity theory of money
• Phillips Curve

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Demand-pull inflation

• Demand-pull inflation happens where there is 'too
  much money chasing too few goods'. Excessive
  growth in demand literally pulls prices up.
• Demand-pull inflation happens when the level of
  aggregate demand grows faster than the underlying
  level of supply. This may be easier to imagine,
  if you think of supply as the level of capacity.
  If our capacity to produce is growing at 3, and
  the level of demand grows at the same rate or
  slower then we don't have a problem. We can
  produce all we need. However, if our capacity
  grows at 3, but demand grows faster, then we
  have a problem. In effect we have 'too much money
  chasing too few goods', and we can't manage to
  produce all we need. Something has to give, and
  it is prices that are forced up, therefore
  causing inflation. We can see all this in the
  diagram below. As the aggregate demand curve
  shifts to the right, the price level rises -
  inflation.

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Demand-pull inflation
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Cost-push inflation

• If costs rise too fast, companies will need to
  put prices up to maintain their margins. This
  will cause inflation.
• Cost-push inflation happens when costs increase
  independently of aggregate demand. It is
  important to look at why costs have increased, as
  quite often costs are increasing simply due to
  the economy booming. When costs increase for this
  reason it is generally just a symptom of
  demand-pull inflation and not cost-push
  inflation. For example, if wages are increasing
  because of a rapid expansion in demand, then they
  are simply reacting to market pressures. This is
  demand-pull inflation causing cost increases.
• However, if wages rise because of greater trade
  union power pushing through larger wage claims -
  this is cost-push inflation. The aggregate supply
  curve shifts left because of the cost increase,
  therefore pushing prices up.

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Cost-push inflation

• So why might costs get pushed up, causing
  inflation? There are a number of possible sources
  of rising costs.
• Wages
• If trade unions gain more power, they may be
  able to push wages up independently of consumer
  demand. Firms then face higher costs and are
  forced to increase their prices to pay the higher
  claims and maintain their profitability.
• Profits
• If firms gain more power and are able to push up
  prices independently of demand to make more
  profit, then this is considered to be cost-push
  inflation. This is most likely when markets
  become more concentrated and move towards
  monopoly or perhaps oligopoly.

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Cost-push inflation

• Exhaustion of natural resources
• As resources run out, their price will
  inevitably gradually rise. This will increase
  firms' costs and may push up prices until they
  find an alternative source of raw materials (if
  they can). This has happened with fish stocks.
  Over-fishing has put many types of fish and
  fish-based products under extreme pressure,
  forcing their price up. In many countries
  equivalent problems have been caused by erosion
  of land when forests have been cleared. The land
  quickly becomes useless for agriculture.
• Taxes
• Changes in indirect taxes (taxes on expenditure)
  increase the cost of living and push up the
  prices of products in the shops. An example would
  be when the level of service tax was increased.

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Cost-push inflation

• Imported inflation
• We now work in a very global economy and many
  firms import a significant proportion of their
  raw materials or semi-finished products. If the
  cost of these increases for reasons out of our
  control, then once again firms will be forced to
  increase prices to pay the higher raw material
  costs.

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Cost-push inflation
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Quantity theory of money

• excessive money supply growth can also be a cause
  of inflation. The quantity theory of money
  explains why this happens.
• The classical economists view of inflation
  revolved around this theory, and this theory was
  in turn derived from the Fisher Equation of
  Exchange. This equation says that
• MV PT
• whereM is the amount of money in circulationV
  is the velocity of circulation of that moneyP is
  the average price level, andT is the number of
  transactions taking place

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Quantity theory of money

• The equation is in fact an identity/truism. It
  says that the amount of the money stock times the
  rate at which it is used for transactions will be
  equal to the number of those transactions times
  the price of each transaction. It will always be
  true, as it simply says that National Income will
  be equal to National Expenditure and basic
  macroeconomics tells us that this is true anyway.
  So nothing stunning there! However, what makes it
  important is what classical economists predicted
  from it.
• Classical economists suggested that V would be
  relatively stable and T would always tend to full
  employment. Therefore they came to the conclusion
  that
• In other words increases in the money supply
  would lead to inflation. The message was simple
  control the money supply to control inflation.

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Phillips Curve

• The Phillips Curve is a relationship between
  unemployment and inflation discovered by
  Professor A.W.Phillips. The relationship was
  based on observations he made of unemployment and
  changes in wage levels from 1861 to 1957. He
  found that there appeared to be a trade-off
  between unemployment and inflation, so that any
  attempt by governments to reduce unemployment was
  likely to lead to increased inflation.
• The curve sloped down from left to right and
  seemed to offer policy makers with a simple
  choice - you have to accept inflation or
  unemployment. You can't lower both. Or, of
  course, accept a level of inflation and
  unemployment that seemed to be acceptable!

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Phillips Curve
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HOW TO CONTROL INFLATION

• Monetary Measures
• Fiscal Measures
• Other Measures

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• Measures to control inflation
• 1. Monetary measures- Classical economists are of
  the view that inflation can be checked by
  controlling the supply of money. Some of the
  important monetary measures to check the
  inflation are as under
•   Control over money-
• It is suggested that to check inflation
  government should put  strict restrictions on the
  issue of money by the central bank.
• Credit control-
• Central bank should pursue credit control policy
  .In order to control the credit it should
  increase the bank rate ,raise minimum cash
  reserve ratio etc. It can also  issue notice to
  other banks in order to control credit

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• 2.Fiscal measures- Measures 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- One of
  the 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 .In order to increase production public
  sector should be expanded and private sector
  should be given more incentives.
• 2 Proper commercial policy- Those goods which
  are in scarcity should be imported as much as
  possible from other countries and their export
  should be discouraged.
• 3 Encouragement to savings During inflation
  government should come out with attractive saving
  schemes. It may issue 5 or 10 year bonds in order
  to attract savings.

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How is it Measured?

• Consumer Price Index
• Wholesale Price Index

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Consumer Price Index

• CPI is a measure estimating the average price of
  consumer goods and services purchased by
  households.
• CPI measures a price change for a constant market
  basket of goods and services from one period to
  the next within the same area (city, region, or
  nation).
• It is a price index determined by measuring the
  price of a standard group of goods meant to
  represent the typical market basket of a typical
  urban consumer. The percent change in the CPI is
  a measure estimating inflation.

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Wholesale Price Index

• WPI was published in 1902,and was one of the
  economic indicators available to policy makers
  until it was replaced by most developed countries
  by the CPI market. index in the 1970.
• WPI is the index that is used to measure the
  change in the average price level of goods traded
  in wholesale market.
• Some countries (like India and The Philippines)
  use WPI changes as a central measure of
  inflation.

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Problems with WPI

• In present day service sector plays a key role in
  Indian economy. Consumers are spending loads of
  money on services like education and health. And
  these services are not incorporated in
  calculation of WPI.
• WPI measures general level of price changes
  either at level of wholesaler or at the producer
  and does not take into account the retail
  margins. Therefore we see here that WPI does give
  the true picture of inflation.
• WPI is supposed to measure impact of prices on
  business. But we use it to measure the impact on
  consumers. Many commodities not consumed by
  consumers get calculated in the index.

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Weight edge to CPI WPI
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Inflation rate

• PI for a certain year - PI for a comparative
  year X 100
• PI for a comparative year

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INFLATION RATES
2006-2007 2007-2008
Inflation 7.8 12.0
Food inflation 10.3 17.6
Non-food inflation 6.2 6.8
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EFFECTS OF INFLATION

• They add inefficiencies in the market, and make
  it difficult for companies to budget or plan
  long-term.
• Uncertainty about the future purchasing power of
  money discourages investment and saving.
• There can also be negative impacts to trade from
  an increased instability in currency exchange
  prices caused by unpredictable inflation.
• Higher income tax rates.
• Inflation rate in the economy is higher than
  rates in other countries this will increase
  imports and reduce exports, leading to a deficit
  in the balance of trade.

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EXAMPLES OF INFLATION

• Increase in the price of wheat
• Increase in the price of oil
• Increase in the price of rice
• Increase in the price of CNG
• Increase in the price of sugar

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Thank you!!!