Inflation, Managing Finance - myBskool | Online Mini MBA (Free)
What is InflationWhat is Inflation
A rise in the general level of prices of goods
and services in an economy
Measured over a period of time.
When the price level rises, each unit of
currency buys fewer goods and services i.e.
decreased purchasing power
When Prices rise, the Value of Money falls.
A chief measure of price inflation is the
Effects of InflationEffects of Inflation
Inflation can have positive and negative effects on
Negative effects of inflation include:
loss in stability in the real value of money and other
monetary items over time;
uncertainty about future inflationary conditions may
discourage investment and saving, and
high inflation may lead to shortages of goods if consumers
begin hoarding out of concern that prices will increase in
Positive effects include:
mitigation of economic recession and
debt relief by reducing the real level of debt.
Stages of InflationStages of Inflation
1. Creeping inflation (0%-3%)
2. Walking inflation (3% - 7%)
3. Running inflation (10% - 20%)
4. Hyper inflation ( 20% and above)
Types of Inflation : Demand PullTypes of Inflation : Demand Pull
Places responsibility for inflation squarely on the
shoulders of increases in aggregate demand.
Increasing aggregate demand means buyers want
more production than the economy is able to
provide i.e. buyers bidding up the price of existing
production. Too much money chasing too few goods!
This type of inflation results when the four
macroeconomic sectors (household, business,
government, and foreign) collectively try to
purchase more output than the economy is capable
The extra demand "pulls" the price level higher.
Causes of Demand Pull InflationCauses of Demand Pull Inflation
a) Depreciation of exchange rate, making exports
more competitive in overseas market
b) Fiscal stimulus e.g. reduction in direct or
indirect taxes or higher government borrowing
or spending on defence, health, education and
c) Monetary stimulus to economy e.g. reduction in
interest rates may lead to demand
d) Improved business confidence, hence more
Types of Inflation: Cost PushTypes of Inflation: Cost Push
Inflation of the economy's average price level
induced by decreases in aggregate supply that
result from increases in production cost.
This type of inflation occurs when the cost of using
any of the four factors of production (labour,
capital, land, or entrepreneurship) increases.
In general, higher production cost means the
economy simply cannot continue to supply the
same production at the same price level. If buyers
want the production, they must pay higher prices.
The higher cost "pushes" the price level higher.
a) Increase in cost of raw materials
b) Rising labour costs - if wages account for 25% of
a firm's total costs then a 10% increase in the
total wage bill will cause the firm's total costs to
rise by 2.5%.
c) Increase in transportation costs
d) Higher taxes imposed by the Government - for
example an increase in fuel duties or a rise in the
standard rate of Value Added Tax.
e) External shocks - this could be either for natural
reasons or because a particular group or country
has gained more economic power (eg. OAPEC)
Causes of Cost Push InflationCauses of Cost Push Inflation
Deflation and ReflationDeflation and Reflation
Deflation is the opposite of Inflation.
Deflation is a state of disequilibria in which a contraction of
purchasing power results in a decline of the price level.
It is a process of reversing inflation without creating
unemployment or reducing the output in the economy.
Reflation is defined as inflation deliberately
undertaken to relieve a depression.
In other words, reflation is a type of controlled inflation.
When deflation is carried to an extreme limit and the prices
of goods and services fall to extremely low levels, then
reflation is employed to protect the economy.
Inflation and India!Inflation and India!
“In other countries, the growth rate is low, but at the same
time inflation is also low. Whereas in our country, while
growth is slowing, inflation remains at a high level.”
Dr Rangarajan, Economic Advisor to the Prime Minister
Inflation Rate WPI (May 2013) : 4.7%
Inflation Rate CPI (May 2013) : 9.31%
All time high (Sept 1974) : 34.7%
Record low (May 1976) : -11.3%
In India, the wholesale price index (WPI) is the main measure
The WPI measures the price of a representative basket of
In India, wholesale price index is divided into three groups:
Primary Articles (20.1% of total weight), Fuel and Power
(14.9%) and Manufactured Products (65%).
Food Articles from the Primary Articles Group account for
14.3% of the total weight.
The most important components of the Manufactured
Products Group are: Chemicals and Chemical products
(12% of the total weight); Basic Metals, Alloys and Metal
Products (10.8%); Machinery and Machine Tools (8.9%);
Textiles (7.3%) and Transport, Equipment and Parts
CPI stands for Consumer Price Index
It is an index which takes into account the standard cost of
living (which includes the weighted average of both
commodities and services).
Also, called Retail Inflation
The CPI has much larger weightage of primary articles
which implies that impact of food inflation is reflected much
more prominently in CPI than in WPI.
CPI is computed under 3 categories, namely, Industrial
Worker (IW), Agricultural Labourer (AL) and Urban Non-
Manual Employees (UNME).
As their names suggest, CPI (IW, AL, UNME) is essentially a
reflector of the standard cost of living of people belonging
to these categories i.e. the majority of India.
Comparison with Emerging MarketsComparison with Emerging Markets
Controlling persistent inflationControlling persistent inflation
Agricultural production in India has not grown in
proportion to the growth in population, thus
creating a supply shortage.
India has seen a rise in prices of raw materials
and wage rates and a shortage of natural
resources - has caused the price level (cost of
goods) to increase.
High fiscal deficit
Change in dietary habits with focus on proteins
Inefficient supply chain management
Where is the real issue?Where is the real issue?
The challenge:The challenge:
Food inflationFood inflation
Food inflation persisting despite large buffer stocks
upward pressure reinforced with significant increase in
the Minimum Support Price (MSP) of most cereals and
cost of agriculture has been going up sharply
Volatility in prices of vegetables and fruits
Significant price increase in protein rich food items, such as,
eggs, fish and meat
The persistence of food inflation calls for:
a relook at the agriculture price policy of the country
revisit of the buffer stock policy
How to combat?How to combat?
Need for policy action on several fronts:
Supply-demand imbalance in the agricultural
sector and modernizing the supply chain
Market related pricing of petroleum products
required to reduce the subsidy burden
Reliability of power supply and availability of
necessary industrial raw materials are important
Stability of exchange rate to cushion
transmission of international price pressures in
commodities, particularly crude oil
Fiscal consolidation is important for maintaining
both domestic and external balance
Final words…Final words…
The threshold level of inflation in India is about five
per cent beyond which inflation harms growth by
putting sands on the wheels of commerce
We are a country with vast labor supply, hence
potential for growth is limitless…….but only in an
environment of price stability, any positive step
can bolster growth.