Engineering Economics

1. Module 1:Economic
Decisions
By.
Dr. Archana Belge

2. What is Economics?
• Economics is the social science that studies the production,
distribution, and consumption of goods and services.
• Economics focuses on the behavior and interactions of economic
agents and how economies work with limited resources.

7. What is inflation and how it works?
• Inflation is an economic indicator that indicates the rate of rising prices of
goods and services in the economy. Ultimately it shows the decrease in the
buying power of the rupee. It is measured as a percentage.
• This percentage indicates the increase or decrease from the previous
period. Inflation can be a cause of concern as the value of money keeps
decreasing as inflation rises.

8. What do you mean by inflation?
• Inflation is a quantitative economic measure of a rate of change in
prices of selected goods and services over a period of time. Inflation
indicates how much the average price has changed for the selected
basket of goods and services. It is expressed as a percentage. Increase
in inflation indicates a decrease in the purchasing price of the
economy.

9. Types of Inflation:
• Demand-pull Inflation: It occurs when the demand for goods or
services is higher when compared to the production capacity. The
difference between demand and supply (shortage) result in price
appreciation.

10. Types of Inflation
• Cost-push Inflation: It occurs when the cost of production increases.
Increase in prices of the inputs (labour, raw materials, etc.) increases
the price of the product.

11. Types of Inflation
• Built-in Inflation: Expectation of future inflations results in Built-in
Inflation. A rise in prices results in higher wages to afford the
increased cost of living. Therefore, high wages result in increased cost
of production, which in turn has an impact on product pricing. The
circle hence continues.

12. What are the main causes of inflation?
• Monetary Policy: It determines the supply of currency in the market.
Excess supply of money leads to inflation. Hence decreasing the value
of the currency.
• Fiscal Policy: It monitors the borrowing and spending of the economy.
Higher borrowings (debt), result in increased taxes and additional
currency printing to repay the debt.

13. What are the main causes of inflation?
• Demand-pull Inflation: Increases in prices due to the gap between
the demand (higher) and supply (lower).
• Cost-push Inflation: Higher prices of goods and services due to
increased cost of production.
• Exchange Rates: Exposure to foreign markets are based on the dollar
value. Fluctuations in the exchange rate have an impact on the rate of
inflation.

14. Who benefits from inflation?
• Inflation being a cause of concern for the economy, doesn’t affect
everyone in a bad way. It is a boon for a certain set of people. While
consumers lose a part of their purchasing power to inflation, investors
gain from it.
• Investors investing in assets affected by inflation, if held on for a long
time will certainly benefit from it. For example, an increase in housing
prices might affect consumers. However, those who have already
bought a house will benefit from capital appreciation.

15. How do we prevent inflation?
• To prevent inflation, the primary strategy is to change the monetary policy by adjusting the
interest rates. Higher interest rates decrease the demand in the economy. This results in lower
economic growth and therefore, lower inflation. Other ways to prevent inflation are:
• Controlling the money supply can also help in preventing inflation.
• Higher Income Tax rate can reduce the spending, and hence resulting in lesser demand and
inflationary pressures.
• Introducing policies to increase the efficiency and competitiveness of the economy helps in
reducing the long term costs.

16. What are the effects of a rise in the inflation
rate?
• A rise in an inflation rate can cause more than a fall in purchase power.
• Inflation could lead to economic growth as it can be a sign of rising
demand.
• Inflation could further lead to an increase in costs due to workers demand
to increase wages to meet inflation. This might increase unemployment as
companies will have to lay off workers to keep up with the costs.
• Domestic products might become less competitive if inflation within the
country is higher. It can weaken the currency of the country.

17. The Consumer Price Index (CPI)
• The Consumer Price Index (CPI) measures the change in income a consumer
needs to maintain the same standard of living over time. The CPI is meant to
reflect changes in the cost of living for a typical urban household.
• For example, suppose every household buys 222 bottles of cod liver oil, 101010
loaves of bread, and 888 dog treats every week. A consumer price index tracks
changes in the price of this unchanging collection of goods over time to measure
changes in the cost of living for this household. Once the CPI is calculated for two
years, we can to calculate the rate of inflation.

18. What is the inflation rate formula?
• Inflation rate formula is the difference between initial CPI and final
CPI divided by initial CPI. The result then multiplied by 100 gives the
inflation rate.
• Rate of Inflation = (Initial CPI – Final CPI/ Initial CPI)*100
• CPI= Consumer Price Index

19. How to calculate inflation rate?
• Inflation is calculated using the Consumer Price Index (CPI). Inflation can be calculated for any
product by following these steps.
• Determine the rate of the product at an earlier period.
• Determine the current rate of the product
• Use the inflation rate formula (Initial CPI – Final CPI/ Initial CPI)*100. Here CPI is the rate of the
product.
• This gives the increase/decrease percentage in the price of the product. One can use this to
compare the inflation rate over a period of time.
• Here we used only one product to calculate inflation. However, the Ministry of Statistics
calculates inflation using a basket of selected goods and services.

20. Content Beyond Syllabus