2. Inflation
Early 20th century Germany had bitter experience of inflation
Price began to rise so fast and high that they began to lose all meaning
Those who failed to shop on the pay day itself were losing their income because price would be very
much higher on the next day
The workers who received their wages were running to the shop to buy essential things because the
price were rising very fast.
Saving of the people became valueless like sand and were washed away in the current of inflation
3. Meaning of Inflation
In the ordinary sense inflation means a rise in the general prise level.
According to Crowther inflation is a state in which the value of money is falling and prices are
rising. This definition has two limitations
1. Ever increase in the prise according to him is inflationary and harmful. But a rise in the price
level during a period of depression is not at all harmful. It is a sign of recovery.
2. Crowther definition touches only the symptoms and not the cause of the inflation
According to Prof. Coulbourn “Inflation is too much money chases too few goods.
According to Milton Friedman “Inflation is always and everywhere a monetary phenomenon.
In short – Inflation is a sustained rise in the general price level.
4. Inflation
Points to remember
Chronic and sustained rise in price caused by in increase in the supply of money.
Too much money chases too few goods
General price level rise and value of money falls
7. A. On the basis of Rate
1. Creeping Inflation : This type of inflation is slow and mild. In the case of under developed countries
creeping inflation is a tonic for economic development. . In terms of speed, a sustained rise in prices
of annual increase of less than 3 per cent per annum is characterized as creeping inflation
2. Walking Inflation : When creeping inflation gathers momentum we experience walking inflation.
Walking inflation is not dangerous but it gives a warning that prices are going to rise faster and faster.
Walking inflation rate is the rise of prices is in the intermediate range of 3 and 7 per annum or less
than 10 per cent.
3. Galloping Inflation : If mild inflation is not checked and if it is allowed to go uncontrolled it may
assume the character of the galloping inflation. It may have adverse effect on the saving and thus may
affect the long term investment projections in the economy. When prices rise rapidly like the running
of a horse at a rate or speed of 10 to 20 per cent per annum. Such inflation affects the poor and middle
classes adversely.
4. Hyper Inflation : A final stage of inflation is Hyper inflation. It occurs when the price line goes out of
control and monetary authorities find it beyond their resources to impose any check on it. When prices
rise very fast at double or triple digit rates from more than 20 to 100 per cent per annum or more.
Types of Inflation
8. 5.Open Inflation : It is a inflationary process in which prices are permitted to rise without being
suppressed by government through price control or similar techniques.
6.Suppressed Inflation: When the government imposes physical and monetary controls to check open
inflation, it is known as repressed or suppressed inflation. But as soon as these controls are removed,
there is open inflation. Moreover, suppressed inflation adversely affects the economy.
7.Reflation: It is a situation when prices are raised deliberately in order to encourage economic activity.
When there is depression and prices fall abnormally low, the monetary authority adopts measures to put
more money in circulation so that prices rise. This is called reflation.
8.Stagflation : It represents the paradoxical co-existence of rising prices on the one hand and
unemployment on the other.
9.Slumpflication : It is experienced mainly in underdeveloped countries owing to the scarcity of essential
inputs.
9. Causes of Inflation
1. Increase in money supply and aggregate demand
2. Rise in cost of production
3. Excessive Exports
4. Excessive credit creation by the commercial banks
5. Deficit Budgeting
6. Black Money
7. Repayment of Internal Public Debt
10. Demand Pull Inflation
Demand pull inflation arises when the aggregate demand exceeds the level of currently available output.
In other words demand pull inflation is caused by an increase in aggregate effective demand for goods and services in the
economy.
Demand pull inflation is a phenomenon of too much money chasing too few goods.
So demand pull inflation occurs when the demand for goods and services exceeds their available supply at the existing prices.
An excess of aggregate demand over aggregate supply will generate inflationary rise in the prices.
Diagram
There are many causes leading to demand pull inflation. Those are
1.increase in money supply
2.increase in disposable income
3.Increase in public expenditure
Deficit financing
Black money
Repayment of public debt etc.
11.
12. Cost Push Inflation
The cost push inflation is due to increase in production costs.
In other words , cost push inflation is caused by wage increases enforced by trade unions and profit increase
by entrepreneurs.
It also caused by an organized attempt on the part of the entrepreneurs or industrialist to push up their profit
margins
Cost push inflation is also known as New Inflation and is caused by either wage push or profit push.
13.
14. Effects of Inflation
Inflation affects different people differently. This is because of the fall in the value of money. When prices rise or the value of
money falls, some groups of the society gain, some lose and some stand in between. Prices of some goods and services rise
faster, of others slowly, and of still others remain unchanged
(A) The effects of inflation on different groups of society
1. Debtors and Creditors: During periods of rising prices, debtors gain and creditors lose. Though debtors return the same
amount of money, but they pay less in terms of goods and services. This is because the value of money is less than when they
borrowed the money. On the other hand, creditors lose. Although they get back the same amount of money which they lent, they
receive less in real terms because the value of money falls.
(2) Salaried Persons: Salaried workers such as clerks, teachers, and other white collar persons lose when there is inflation. The
reason is that their salaries are slow to adjust when prices are rising.
(3) Wage Earners: Wage earners may gain or lose depending upon the speed with which their wages adjust to rising prices. If
their unions are strong, they may get their wages linked to the cost of living index. In this way, they may be able to protect
themselves from the bad effects of inflation. But the problem is that there is often a time lag between the raising of wages by
employees and the rise in prices
(4) Fixed Income Group: The recipients of transfer payments such as pensions, unemployment insurance, social security, etc.
and recipients of interest and rent live on fixed incomes. Pensioners get fixed pensions. All such persons lose because they
receive fixed payments, while the value of money continues to fall with rising prices
15. (6) Businessmen: Businessmen of all types, such as producers, traders and real estate holders gain during
periods of rising prices. When prices are rising, the value of their inventories rise in the same proportion. So they
profit more when they sell their stored commodities.
(7) Agriculturists: For prices of inputs and land revenue do not rise to the same extent as the rise in the prices of
farm products. On the other hand, the landless agricultural workers are hit hard by rising prices. Their wages are
not raised by the farm owners because trade unionism is absent among them. But the prices of consumer goods rise
rapidly. So landless agricultural workers are losers
(8) Government
16. (B) Effects on Production:
1. Misallocation of Resources: Inflation causes misallocation of resources when producers divert
resources from the production of essential to non-essential goods from which they expect higher
profits
2. Reduction in Production: Inflation adversely affects the volume of production because the
expectation of rising prices along with rising costs of inputs brings uncertainty. This reduces
production
3. Fall in Quality: Continuous rise in prices creates a seller’s market. In such a situation, producers
produce and sell sub-standard commodities in order to earn higher profits. They also indulge in
adulteration of commodities
17. 1. Hoarding and Black-marketing: To profit more from rising prices, producers hoard stocks of
their commodities. Consequently, an artificial scarcity of commodities is created in the market.
Then the producers sell their products in the black market which increase inflationary pressures.
2. Reduction in Saving: When prices raise rapidly, the propensity to save declines because more
money is needed to buy goods and services than before. Reduced saving adversely affects
investment and capital formation. As a result, production is hindered.
3. Encourages Speculation: Rapidly rising prices create uncertainty among producers who
indulge in speculative activities in order to make quick profits. Instead of engaging themselves in
productive activities, they speculate in various types of raw materials required in production
18. 1. Government: Inflation affects the government in various ways. It helps the government in financing
its activities through inflationary finance. As the money income of the people increases, the
government collects that in the form of taxes on incomes and commodities. So the revenues of the
government increase during rising prices. Moreover, the real burden of the public debt decreases
when prices are rising
2. Balance of Payments: Inflation adversely affects the balance of payments of a country. When prices
rise more rapidly in the home country than in foreign countries, domestic products become costlier
compared to foreign products. This tends to increase imports and reduce exports, thereby making the
balance of payments unfavorable for the country.
3. Collapse of the Monetary System: If hyperinflation persists and the value of money continues to fall
many times in a day, it ultimately leads to the collapse of the monetary system, as happened in
Germany after World War I.
(c) Other Effects:
19. (4) Social. Inflation is socially harmful: By widening the gulf between the rich and the poor,
rising prices create discontentment among the masses. Pressed by the rising cost of living, workers
resort to strikes which lead to loss in production. Lured by profit, people resort to hoarding, black-
marketing, adulteration, manufacture of substandard commodities, speculation, etc. Corruption
spreads in every walk of life. All this reduces the efficiency of the economy.
(5) Political: Rising prices also encourage agitations and protests by political parties opposed to
the government. And if they gather momentum and become unhandy they may bring the downfall
of the government. Many governments have been sacrificed at the altar of inflation
20. Measures to Control Inflation
1. Monetary Measures: Monetary measures aim at reducing money incomes.
(a) Credit Control: One of the important monetary measures is monetary policy. The central bank
of the country adopts a number of methods to control the quantity of credit. For this purpose, it raises
the bank rates, sells securities in the open market, and raises the reserved ratio.
(b) Demonetization of Currency: One of the monetary measures is to demonetize currency of
higher denominations. Such a measure is usually adopted when there is abundance of black money in
the country.
(c) Issue of New Currency: Under this system, one new note is exchanged for a number of notes of
the old currency. Such a measure is adopted when there is an excessive issue of notes and there is
hyperinflation in the country. It is a very effective measure. But is inequitable for it hurts the small
depositors the most.
21. 2. Fiscal Measures: Monetary policy alone is incapable of controlling inflation. It should, therefore,
be supplemented by fiscal measures. Fiscal measures are highly effective for controlling
government expenditure, personal consumption expenditure, and private and public investment.
(a) Reduction in Unnecessary Expenditure: The government should reduce unnecessary ex-
penditure on non-development activities in order to curb inflation. But it is not easy to cut
government expenditure and it becomes difficult to distinguish between essential and non-essential
expenditure. Therefore, this measure should be supplemented by taxation.
(b) Increase in Taxes: To cut personal consumption expenditure, the rates of personal, corporate
and commodity taxes should be raised and even new taxes should be levied, but the rates of taxes
should not be as high as to discourage saving, investment and production. To increase the supply of
goods within the country, the government should reduce import duties and increase export duties.
22. (c) Increase in Savings: Another measure is to increase savings on the part of the people. This will
tend to reduce disposable income with the people, and hence personal consumption expenditure. For
this purpose, the government should float public loans carrying high rates of interest, start saving
schemes, introduce compulsory provident fund, provident fund-cum-pension schemes, etc. All such
measures to increase savings are likely to be effective in controlling inflation.
(d) Surplus Budgets: An important measure is to adopt anti-inflationary budgetary policy. For this
purpose, the government should give up deficit financing and instead have surplus budgets. It means
collecting more in revenues and spending less.
Like the monetary measures, fiscal measures alone cannot help in controlling inflation. They should
be supplemented by monetary, non-monetary and non-fiscal measures
23. 3. Other Measures: The other types of measures are those which aim at increasing aggregate supply and
reducing aggregate demand directly:
(a) To Increase Production: One of the foremost measures to control inflation is to increase the
production of essential consumer goods like food, clothing, kerosene oil, sugar, vegetable oils, etc. All
possible help in the form of latest technology, raw materials, financial help, subsidies, etc. should be
provided to different consumer goods sectors to increase production.
(b) Rational Wage Policy: Another important measure is to adopt a rational wage and income policy.
Under hyperinflation, there is a wage-price spiral. To control this, the government should freeze wages,
incomes, profits, dividends, bonus, etc. It will control wages and at the same time increase productivity,
and hence increase production of goods in the economy.
(c) Price Control: Price control and rationing is another measure of direct control to check inflation.
Price control means fixing an upper limit for the prices of essential consumer goods. They are the
maximum prices fixed by law and anybody charging more than these prices is punished by law. But it is
difficult to administer price control.
(d) Rationing: Rationing aims at distributing consumption of scarce goods so as to make them available
to a large number of consumers. It is applied to essential consumer goods such as wheat, rice, sugar,
kerosene oil, etc. It is meant to stabilize the prices of necessaries and assure distributive justice.
24. Deflation is a general decline in prices for goods and services, typically associated with a
contraction in the supply of money and credit in the economy. During deflation, the purchasing
power of currency rises over time.
1.Deflation is the general decline of the price level of goods and services.
2.Deflation is usually associated with a contraction in the supply of money and credit, but prices
can also fall due to increased productivity and technological improvements.
3.Whether the economy, price level, and money supply are deflating or inflating changes the
appeal of different investment options
Deflation
26. Business Cycle or Trade Cycle refers to the phenomenon of cyclical booms and depression.
In a business cycle there are wave like fluctuations in aggregate employment, income, output
and price-level. It consists of recurring alternation of expansion and contraction in aggregate
economic activity.
Generally, the cyclical fluctuations have a tendency towards simultaneous appearance in all
the branches of the national economy. But sometimes they may be confined only to individual
industries or individual sectors of the economy.
Business Cycle
27. 1. Business cycles occur periodically. Though they do not show same regularity, they have some
distinct phases such as expansion, peak, contraction or depression and trough. Further the duration of
cycles varies a good deal from minimum of two years to a maximum of ten to twelve years.
2. Secondly, business cycles are Synchronic. That is, they do not cause changes in any single
industry or sector but are of all embracing character. For example, depression or contraction occurs
simultaneously in all industries or sectors of the economy. Recession passes from one industry to
another and chain reaction continues till the whole economy is in the grip of recession. Similar
process is at work in the expansion phase, prosperity spreads through various linkages of input-output
relations or demand relations between various industries, and sectors
3. Thirdly, it has been observed that fluctuations occur not only in level of production but also
simultaneously in other variables such as employment, investment, consumption, rate of interest
and price level.
Features of Business Cycles:
28. 4. Investment and consumption of durable consumer goods such as cars, houses, and
refrigerators are affected most by the cyclical fluctuations. As stressed by J.M. Keynes,
investment is greatly volatile and unstable as it depends on profit expectations of private
entrepreneurs. These expectations of entrepreneurs change quite often making investment quite
unstable. Since consumption of durable consumer goods can be deferred, it also fluctuates greatly
during the course of business cycles
5. Consumption of non-durable goods and services does not vary much during different phases
of business cycles. Past data of business cycles reveal that households maintain a great stability in
consumption of non-durable goods.
29. Types of Business Cycles
There are five types of cycles which are as follows:
1. The Minor Cycle: This is also known as Short Kitchin Cycle. This has gained popularity after the name of the British economist
Joseph Kitchin in the year 1923. He made a research and came to this conclusion that a cycle takes place within duration of
approximately 30 to 40 months.
2. The Major Cycle: This has been emphasized as the fluctuation of business activity between successive crises. This is also known as
“The Long Jugler Cycle.” A French economist Clement Jugler showed that the periods of prosperity, crisis and liquidation followed
each other always within a span of the average of nine and half years.
3. The Very Long Period Cycle: This is also known as Kondratieff Cycle. This was propounded by N. D. Kondratieff the Russian
economist in the year 1925. He has written that there are longer waves of cycles of more than fifty years duration.
4. Kuznets Cycle: This type of business cycle was propounded by the famous American economist Professor Simon Kuznet. His view
was that the secular swing of the cycle generally occurs in between 7 to 11 years and this can show effect within that period.
5. Building Cycles: Such cycles are associated with the name of two American economists namely Warren and Pearson. They
expressed their views in World Prices and the Building Industry book in the year 1937. Their view was that business cycle occurs in the
duration of an average of 18 years and the cost of such cycle has major effect on building construction and on the industrial
development.
30. Phases of Business Cycle
A typical or standard business cycle is characterized by five different phases or stages-depression, recovery
(or, revival), prosperity (or, full employment), boom (or, overfull employment), and recession.
31. Depression
This constitutes the first stage of a business cycle. It is a protracted period in which business activity in
the country is far below the normal. It is characterized by a sharp reduction of production, mass
unemployment, low employment, falling prices, falling profits, low wages, contraction of credit, a
high rate of business failures and an atmosphere of all-round pessimism and despair. A decline in
output or production is accompanied by a reduction in the volume of employment. All construction
activities come to a more or less complete standstill during a depression. The consumer-goods
industries, such as, food, clothing, etc. are not so much affected by unemployment as the basic capital
goods industries. The prices of manufactured goods fall to low levels. Since the costs are “sticky” and
do not fall as rapidly as prices, the manufacturers suffer huge financial losses. Many of these firms
have to close down on account of accumulated losses.
32. Recovery (or, Revival)
It implies increase in business activity after the lowest point of the depression has been reached. During
this phase, there is a slight improvement in economic activity, to start with. The entrepreneurs being to
feel that the economic situation was, after all, not so bad as it was in the preceding stage. This leads to
further improvement in business activity. The industrial production picks up slowly and gradually. The
volume of employment also steadily increases. There is a slow, but sure, rise in prices, accompanied by
a small rise in profits. The wages also rise, though do not rise in same proportion in which the prices
rise. Attracted by rising profits, new investments take place in capital goods industries. The banks
expand credit. The business inventories also start rising slowly. The pessimism and despair of the
preceding period is replaced by an atmosphere of all-round cautious hope.
33. Prosperity (or, Full Employment)
This stage is characterized by increased production, high capital investment in basic industries,
expansion of bank credit, high process, high profits, a high rate of formation of new business
enterprises and full employment. There is a general feeling of optimism among businessmen and
industrialists
34. It is the stage of rapid expansion in business activity to new high marks, resulting in high stocks
and community prices, high profits and overall employment. The prosperity phase of the business
cycle does not end up with a stable state of full employment; it leads to the emergence of boom.
The continuance of investment even after the stage of full employment results in a sharp inflationary
rise of prices. This causes undue optimism among businessmen and industrialists who make additional
investments in the various branches of the economy.
Boom (or, Overall Employment)
35. The feeling of over-optimism of the earlier period is replaced now by over-pessimism
characterized by fear and hesitation on the part of the businessmen. The failure of some
business creates panic among businessmen. The banks also get panicky and begin to withdraw
loans from business enterprises. More business enterprises fail. Prices collapse and
confidence is rudely shaken. Building construction slows down and unemployment
appears in basic, capital goods industries. This capital unemployment then spreads to
other industries. Unemployment leads to fall in income, expenditure, prices and profits. The
recession, it should be remembered, has cumulative effect. Once a recession starts, it goes on
gathering momentum and finally assumes the shape of depression-the first phase of the
business cycle complete.
Recession
