Inflation

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Inflation

  1. 1. INFLATION
  2. 2. WHAT IS INFLATION ? <ul><li>Inflation is a rise in general level of prices of goods and services in the country over a period of time. </li></ul><ul><li>As the cost of goods and services increase, the value of a currency declines because you won't be able to purchase as much with that currency as you could have last month or last year. </li></ul>
  3. 3. HOW IS INFLATION MEASURED ? <ul><li>Wholesale Price Index ( WPI ) </li></ul><ul><li>Consumer Price Index ( CPI ) </li></ul><ul><li>GDP Deflator </li></ul>
  4. 4. WHOLESALE PRICE INDEX <ul><li>The Wholesale Price Index (WPI) was first published in 1902 . It consists of over 2,400 commodities. </li></ul><ul><li>The Wholesale Price Index or WPI is the price of a representative basket of wholesale goods. </li></ul><ul><li>The Wholesale Price Index focuses on the price of goods traded between corporations. </li></ul>
  5. 5. CONSUMER PRICE INDEX <ul><li>CPI is a measure of a weighted average of prices of a specified set of goods and services purchased by consumers. </li></ul><ul><li>It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation. </li></ul><ul><li>Most developed countries uses this index. </li></ul>
  6. 6. WEIGHT EDGE TO WPI AND CPI
  7. 7. GDP DEFLATOR <ul><li>GDP Deflator refers to the ratio between GDP at current prices and GDP at constant prices. </li></ul><ul><li>GDP Deflator = </li></ul>GDP at Current Prices GDP at Constant Prices
  8. 8. CLASSIFICATION OF INFLATION <ul><li>CORE INFLATION </li></ul><ul><li>HEADLINE INFLATION </li></ul>
  9. 9. CAUSES OF INFLATION <ul><li>Demand Pull Inflation </li></ul><ul><li>Cost Push Inflation </li></ul>
  10. 10. DEMAND PULL INFLATION <ul><li>Demand-pull inflation is an inflation that results from an initial increase in aggregate demand. </li></ul><ul><li>Demand-pull inflation in short run </li></ul><ul><li>Demand-pull inflation in long run </li></ul>
  11. 11. DEMAND-PULL INFLATION IN SHORT RUN <ul><li>In the above diagram AD shifts to AD’ because of increase in demand & that result in increase of price level from P to P’ & increase of real GDP from Y to Y’ . </li></ul>SRAS AD AD' REAL GDP PRICE LEVEL P' P Y Y' a b
  12. 12. DEMAND-PULL INFLATION IN LONG RUN <ul><li>Starting from full employment, an increase in aggregate demand shifts the AD curve rightward. </li></ul>REAL GDP PRICE LEVEL AD AD' SRAS a b c SRAS' LRAS P P' Y Y' P&quot;
  13. 13. <ul><li>Real GDP increases, the price level rises. </li></ul><ul><li>The higher level of output means that real GDP exceeds potential GDP. </li></ul><ul><li>The SRAS curve shifts leftward. </li></ul><ul><li>Real GDP decreases back to potential GDP but the price level rises further. </li></ul><ul><li>Aggregate demand keeps increases and the process just described repeats indefinitely. </li></ul><ul><li>Demand-pull inflation occurred in the United States during the late 1960s and early 1970s. </li></ul>
  14. 14. COST PUSH INFLATION <ul><li>Cost-push inflation develops because the higher costs of production factors decreases in aggregate supply ( the amount of total production ) in the economy.  Because there  are fewer goods being produced (supply weakens)  and demand for these goods remains consistent, the prices of finished goods increase (inflation) </li></ul><ul><li>There are two main sources of increased costs </li></ul><ul><li>An increase in the money wage rate </li></ul><ul><li>An increase in the money price of raw materials, such as oil. </li></ul>
  15. 15. COST PUSH INFLATION IN SHORT RUN <ul><li>In the above diagram SRAS shifts to SRAS’ because of decrease in supply & that result in increase of price level from P to P’ & decrease of real GDP from Y to Y’ . </li></ul>AD SRAS SRAS' a b REAL GDP PRICE LEVEL P P' Y Y'
  16. 16. COST PUSH INFLATION IN LONG RUN <ul><li>A rise in the price of goods decreases short-run aggregate supply and shifts the SRAS curve leftward. </li></ul>PRICE LEVEL AD AD' SRAS a b c SRAS' LRAS P P' Y Y' P&quot; REAL GDP
  17. 17. <ul><li>Real GDP decreases and the price level rises a combination called stagflation. </li></ul><ul><li>The initial increase in costs creates a one-time rise in the price level, not inflation. To create inflation, aggregate demand must increase. </li></ul><ul><li>The increase in aggregate demand shifts the AD curve rightward. Real GDP increases and the price level rises again. </li></ul><ul><li>Cost-push inflation occurred in the United States during 1974–1978. </li></ul>
  18. 18. EFFECT OF INFLATION <ul><li>Effect on Economic Development : Rapid rise in prices is detrimental to the process of growth and development as, it adversely impacts the rate of saving and investment. </li></ul><ul><li>Effect on Foreign Investment : Price rise has an adverse effect on the foreign investment in the country. Foreign investors do not invest in those countries where the value of money tends to constantly eroding. </li></ul><ul><li>Adverse Effect on the People with Fixed Income : Price rise has an adverse effect on the people with fixed income. On account of rise in price level, the real value of their monetary income goes down. They can buy less goods than before. Their standard of living falls </li></ul>
  19. 19. <ul><li>Increase in Cost : Cost of projects (both private & public sector) tends to ramp up due to rise in prices. As a result, plan layouts had to frequently revised to achieve the stipulated targets. However, when the planners fail to find additional resources, plan targets are to be sacrificed. </li></ul><ul><li>Adverse Impact on Balance of Payments : Owing to inflation, exports become expensive. Domestic goods lose their competitiveness in the international market. Exports, therefore, tend to fall. On the other hand, imports tend to become relatively cheaper. Accordingly, balance of trade, and therefore, balance of payments tend to become unfavorable . </li></ul>
  20. 20. <ul><li>Inequality : A situation of consistent rise in the price level tends to aggravate inequality in the distribution of income & wealth. Often, it is observed that during inflation profits tend to rise faster than wages. Accordingly, while the capitalists accumulate wealth and capital, the proletariats suffer deprivation. </li></ul>
  21. 21. POLICY OF GOVERNMENT TO CHECK INFLATION <ul><li>Monetary Policy </li></ul><ul><li>Fiscal Policy </li></ul><ul><li>Price Policy </li></ul>
  22. 22. MONETARY POLICY <ul><li>Monetary policy refers to that policy through which the government or Reserve Bank of India controls the supply of money , availability of money and the rate of interest in order to attain a set of objectives focusing on the price stability and economic growth of the country. Monetary measures focuses on controlling the supply of money as the most patent means of checking inflation. </li></ul>
  23. 23. Instrument of Monetary Policy <ul><li>Bank Rate </li></ul><ul><li>Open Market Operation </li></ul><ul><li>Cash Reserve Ratio </li></ul><ul><li>Statutory Liquidity Ratio </li></ul>
  24. 24. Bank Rate <ul><li>Rate of interest or rate of discount that the Reserve Bank charges from the member bank on the loans given to them is called bank rate. </li></ul>
  25. 25. Open Market Operations <ul><li>Open market operations is yet another technique adopted by the Reserve Bank for quantitative credit control. This means that the bank controls the flow of credit through the sale and purchase of government securities in the open market. </li></ul>
  26. 26. Cash Reserve Ratio <ul><li>The Cash Reserve Ratio (CRR) refers to this liquid cash that banks have to maintain with the Reserve Bank of India (RBI) as a certain percentage of their demand and time liabilities. </li></ul>
  27. 27. Statutory Liquidity Ratio <ul><li>Statutory Liquidity Ratio (SLR) is a term used in the regulation of banking in India. It is the amount which a bank has to maintain in the form of cash , gold or approved securities. </li></ul>
  28. 28. FISCAL POLICY <ul><li>Fiscal policy  is the means by which a government adjusts its levels of spending in order to monitor and influence a nation's economy. </li></ul>
  29. 29. Instrument of Fiscal Policy <ul><li>Taxation Policy </li></ul><ul><li>Government Expenditure Policy </li></ul><ul><li>Deficit Financing </li></ul>
  30. 30. Taxation Policy <ul><li>Taxation forces the people to save for the government. The government uses taxation as a powerful instrument to increase or decrease the real purchasing power of the people. </li></ul>
  31. 31. Government Expenditure Policy <ul><li>Aggregate demand is influenced by government expenditure. On account of increase in public ( government ) expenditure there is increase in aggregate demand and vice versa. Public expenditure can be of two types: </li></ul><ul><li>Public expenditure incurred to buy goods & services </li></ul><ul><li>Public expenditure incurred on transfer payments </li></ul>
  32. 32. Deficit Financing <ul><li>It refers to financing of the deficit in government budget. When the government meets its budgetary deficit by borrowing from the Central Bank, it is called deficit financing. </li></ul>
  33. 33. PRICE POLICY <ul><li>Price policy refers to the policy of directing, regulating and controlling the relative price structure of the economy in such a manner that it favorably impacts the macro economic parameters like ; consumption , saving, investment, production, etc. </li></ul>
  34. 34. Instrument of Price Policy <ul><li>Price control </li></ul><ul><li>Administered price </li></ul><ul><li>Procurement price </li></ul><ul><li>Support price </li></ul><ul><li>Dual pricing </li></ul>
  35. 35. Price Control <ul><li>Prices of certain essential goods are controlled with a view to ensuring their availability to vulnerable sections of the society . </li></ul>
  36. 36. Administered price <ul><li>In case of certain public sector enterprises and departmental undertakings, producing goods & services of intermediate consumption, policy of ‘administered price’ is pursued as an instrument of price policy. </li></ul>
  37. 37. Procurement price <ul><li>It refers to price fixed by the government at which it procures a part of the farmer’s produce to run its PDS (Public Distribution System). </li></ul>
  38. 38. Support price <ul><li>Support price is that price which is offered by the government to the farmers for the purchase of their surplus output. </li></ul>
  39. 39. Dual pricing <ul><li>Dual pricing is another important instrument of price policy in India. It implies sale of certain commodities (like kerosene oil at present, and cement and sugar in the recent past) at the controlled price to vulnerable sections of the society and at the open market price to the others. </li></ul>
  40. 40. THANK YOU

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