Inflation

Inflation in
india

Ghanshyam iilm gurgaon 1/24/2012 10:20 PM 1

 “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. price are rising.”


 On the basis of rate of inflation
 On the basis of degree of control
 On the basis of causes
 Others


 Cost push inflation
 Demand pull inflation


 Cost push inflation may arise because
of :
a) Increase in money wage rates
b) Increase in money prices of raw
materials.


 When there is a decrease in the aggregate supply of
goods and services stemming from an increase in the
cost of production, we have cost-push inflation.

 Cost-push inflation basically means that prices have
been “pushed up” by increases in costs of any of the
four factors of production (labor, capital, land or
entrepreneurship) when companies are already
running at full production capacity.

 With higher production costs and productivity
maximized, companies cannot maintain profit
margins by producing the same amounts of goods
and services. As a result, the increased costs are
passed on to consumers, causing a rise in the general
price level (inflation).


 To visualize how cost-push inflation works,
we can use a simple price-quantity graph
showing what happens to shifts in
aggregate supply. The graph below shows
the level of output that can be achieved at
each price level. As production costs
increase, aggregate supply decreases from
AS1 to AS2 (given production is at full
capacity), causing an increase in the price
level from P1 to P2. The rationale behind this
increase is that, for companies to maintain
(or increase) profit margins, they will need
to raise the retail price paid by consumers,
thereby causing inflation


 Demand pull inflation may be due to :
a) Increase in money supply
b) Increase in government purchases
c) Increase in exports


 Demand-pull inflation occurs when there is an
increase in aggregate demand, categorized by the
four sections of the macroeconomy: households,
businesses, governments and foreign buyers.

 When these four sectors concurrently want to
purchase more output than the economy can
produce, they compete to purchase limited amounts
of goods and services.

 Buyers in essence “bid prices up”, again, causing
inflation. This excessive demand, also referred to as
“too much money chasing too few goods”, usually
occurs in an expanding economy.


 As companies increase production due to
increased demand, the cost to produce each
additional output increases, as represented by
the change from P1 to P2.
 The rationale behind this change is that
companies would need to pay workers more
money (e.g. overtime) and/or invest in
additional equipment to keep up with
demand, thereby increasing the cost of
production.
 Just like cost-push inflation, demand-pull
inflation can occur as companies, to maintain
profit levels, pass on the higher cost of
production to consumers’ prices.


 Monetary Measures
 Fiscal Measures
 Other Measures


 Credit Control
 Demonetization of Currency
 Issue of New Currency


 Reduction in Unnecessary Expenditure
 Increase in Taxes
 Increase in Savings
 Surplus Budgets
 Public Debt


 To Increase Production
 Rational Wage Policy
 Price Control


 Consumer Price Index
 Wholesale 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.


 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.
However, India and the United States now report
a producer price index instead.


 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.

 Increase in the price of wheat
 Increase in the price of world oil
 Increase in the price of rice
 Increase in the price of CNG


 A condition of slow economic growth and
relatively high unemployment
accompanied by inflation.
 This happened to a great extent during the
1970s, when world oil prices rose
dramatically, fueling sharp inflation in
developed countries.
 Are we seeing that about to happen in
early 2008?
 At least some central banks have expressed
concern over inflation even as the global
economy seems to be slowing down.

 In 1958, a New Zealand economist , A.W.H.
Phillips proposed that there was a trade-off
between inflation and unemployment.
 The lower the unemployment rate, the
higher was the rate of inflation.
 Governments simply had to choose the
right balance between the two evils.
 Economies did seem to work like this in the
1950s and 1960s, but then the relationship
broke down.


 1958 – Professor A.W. Phillips
 Expressed a statistical relationship between
the rate of growth
of money wages and unemployment
from 1861 – 1957
 Rate of growth of money wages
linked to inflationary pressure
 Led to a theory expressing a trade-off
between inflation and unemployment

Wage growth %
(Inflation)

The Phillips Curve shows an inverse relationship
between inflation and unemployment. It suggested
that if governments wanted to reduce
unemployment it had to accept higher inflation as a
trade-off.
2.5% Money illusion – wage rates rising but individuals
not factoring in inflation on real wage rates.

1.5%

4% 6% Unemployment (%)
PC1

 Problems:
 1970s – Inflation
and unemployment rising
at the same time – stagflation
 Phillips Curve redundant?
 Or was it moving?

Wage growth %
(Inflation)

An inward shift of the Phillips Curve would result in
lower unemployment levels associated with higher
inflation.

3.0%

1.5%

4% 6%
PC1 Unemployment (%)

PC2

Inflation Long Run PC

To countershort term fall in unemployment but at aof
There is athe economy starts with an inflation rate once
Assume the rise in unemployment, government
cost of higher high unemployment at 7%. – the result is
again injects resources Individuals now base their
1% but very inflation. into the economy
aGovernment takes measures to but higher inflation in
wage negotiations unemploymentreduce
short-term fall in on expectations of inflation.
This higher inflationan expansionary fiscal policy firms
the next period. If higher wages are granted then that
unemployment by fuels further expectation of higher
costs rise – they start to(seecontinues. The long run
inflation and to the right shed labour and
pushes AD so the process the AD/AS diagram on
Phillips Curve is vertical at the to 7% rate of
unemployment creeps back upnatural again.
slide 15)
unemployment. This is how economists have explained
3.0% the movements in the Phillips Curve and it is termed the
Expectations Augmented Phillips Curve.

2.0%

1.0%
PC1
7% PC2 Unemployment
PC3

 Where the long run Phillips Curve cuts the
horizontal axis would be the rate of
unemployment at which inflation was
constant –
the so-called
Non-Accelerating Inflation Rate of
Unemployment (NAIRU)

 To reduce unemployment
to below the natural rate
would necessitate:
1. Influencing expectations – persuading
individuals that inflation was going to fall
2. Boosting the supply side of the economy -
increase capacity (pushing the PC curve
outwards)

 Supply side policies have been focused on:
 Education:
› Boosting the number of those staying on at school
› Boosting numbers going to university
› Lifelong learning
› Vocational education
 Welfare benefits:
› The working family tax credit
› Incentives to work
 Labour market flexibility

 Expectations have been centred on:
› Operational independence of the Bank of
England
› Tight control
of public sector pay

The independence of the Bank of England has taken away interest rate decision making from the
government who may have been motivated by political ends – this has had the effect of influencing
expectations.

Inflation

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