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  1. 1. Introduction to Economics ECO-101 Inflation Instructor: Miss Isma Khatoon
  2. 2. Inflation • Inflation is defined as continuous increase in general price level. • “When the general level of prices for goods and services is rising and subsequently purchasing power is falling.” • “Inflation can be thought of as a decrease in the value of the unit of currency.”
  3. 3. • As inflation rises, every dollar will buy a smaller percentage of goods. ( purchasing power of each unit of currency falls, as you can buy less now than before) • Most of the country’s central bank tries to sustain an inflation rate of 2-3%.
  4. 4. There are several variations in Inflation • Stagflation is the combination of high inflation and low growth rate in the economy. • Deflation is when the general level of prices is falling. This is the opposite of inflation. • Hyperinflation is unusually rapid inflation. In extreme case this can lead to the broke down of nation’s monetary system.
  5. 5. Types of inflation • There are two types of inflation 1) Demand pull inflation This theory can be summarized as “ too much money chasing too few goods”. In other words, if demand is growing faster than supply, price will increase. This usually occur in growing economies. AD>AS→ increase in prices → demand is pulling Prices upward
  6. 6. Cost push inflation • When companies costs go up, they need to increase prices to maintain their profit margin. Increased costs can include things such as wages, taxes or increased cost of imports. • Inflation at the cost/ supply side of the economy.
  7. 7. • Increase in the cost of raw material/energy inputs→ increase in per unit production cost → increase in production prices • Per unit production cost Average cost of a particular level of output per unit production cost = total input cost units of output Rising per unit production costs → profit decrease → output decrease at the existing price level→
  8. 8. Main price indexes measure inflation 1. Consumer price index (CPI) CPI measures the variation in cost of buying (prices) of representative market basket of goods and services. The CPI measures price change from the perspective of the purchaser. • It covers 374 items in 35 major cities. It computes on monthly basis. • CPI is calculated at the base year of 2000-01.
  9. 9. 2. Producer Price Index (PPI) A family indexes that measure the average change overtime in selling prices by domestic producers of goods and services. PPI measure price change from the perspective of seller, an earlier version of PPI was called the Wholesale Price Index. 3. Core Inflation Core inflation is a measure of inflation which excludes certain items that face volatile price movements such as Food and fuel prices.
  10. 10. 4. GDP deflator GDP deflator is measure of the prices of all goods and services included in Gross Domestic Product. GDP deflator = Nominal GDP Real GDP 5. Sensitive price index it computes on weekly basis to assess the price movements of essential commodities at short intervals so as to review the price situation in the economy. It is computed from 17 major cities.
  11. 11. Calculating CPI • The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them: the goods are weighted according to their importance. • CPI = Price of the most recent market basket in the particular year price estimate of the same market basket in the recent year X100
  12. 12. Rate of Inflation • Rate of inflation for a certain year is found by comparing, in percentage terms, that year’s index (CPI) with the index in previous year. • Rate of inflation = CPI2 -CPI1 CPI1
  13. 13. Causes of inflation in Pakistan 1. International inflation 2. Increase in wages 3. Population pressure 4. Increase in money supply 5. Fall in production 6. Foreign aid 7. No limits to growth 8. Improper economic policies 9. Persistent deficit in BOP 10. Defective social structure
  14. 14. (1 )International inflation • Globalization→ world is global village now • Each country is interconnected and affected by world prices • As Pakistan importer of edible oil, machinery, oil, chemicals etc. • So world prices affect inflation in the country
  15. 15. (2) Increase in wages • Price increases→ demand for increase in wages → cost of production of producer will increase, ultimately increase prices. (3) population pressure population of Pakistan population growth rate Pop increase→ demand increase → prices inc
  16. 16. (4) Increase in Money supply Reason of this increase i. Decrease in the rate of interest ii. Increase in remittances iii. Increased non productive expenses of Gov iv. Decreased saving and investment v. Decrease in taxable capacity
  17. 17. (5) Fall in production • Agriculture sector problems • Water logging • Salinity • Agricultural diseases • Pests and insects • Floods and droughts • Results decrease in production, AS<AD→ P↑ • Same as industrial production
  18. 18. (6) Foreign Aid • Non- Productive loans increased • Productive loans decreased • No increase in output • Demand and expenses increase→ prices↑ (7) International demonstration affect demand for luxury items increased
  19. 19. (8) Improper economic policies • Political instability • Unlimited power with bureaucracy (9) Persistent deficit in BOP imports > exports Demand for $ > Supply of $ Depreciation and devaluation of currency → increased import prices
  20. 20. Measures to control inflation • Fiscal measures • Monetary measures • Structural measures
  21. 21. 1. Fiscal measures • Decrease in non-developmental expenditures by the government • Increase in taxes 2. Monetary Measures • increase in discount rate by SBP • Selling government securities by SBP • Increase in reserve ratio by SBP
  22. 22. 3. Structural Measures • Increase in industrial and agricultural production • Exploration of mineral resources • Population control • Price controls • Link between productivity and wages • Change in life style
  23. 23. Remedies of Inflation 1. Reduce Demand Pressure if inflation is caused by high demand then: i. Increase interest rate to reduce consumers disposable income. ii. Raise interest rate to discourage borrowing iii. Raise taxes to reduce disposable income and spending
  24. 24. 2. Reduce Cost Push Pressure • If inflation is caused by high costs i. Limit wage increases if possible e.g. public sector workers ii. Force electricity and gas companies to hold their prices iii. Increase the value of currency in order to reduce the cost of importing
  25. 25. 3. Reduce Money Supply Pressure • If inflation is caused by too much money in the economy • Print less money • Withdraw some money from circulation Whereas each of the above mention methods have some advantages and disadvantages.