2. Define Inflation
• Inflation is defined as a general rise in prices of all commodities
manufactured and consumed within the territory of a nation
• Inflation means a sustained increase in the aggregate or general price
level in an economy. Inflation means there is an increase in the cost of
living.
3. Characteristics or Features Of Inflation
• Inflation involves a process of the rise in prices.
• Inflation is dynamic in nature.
• Inflation is caused by excess demand in relation to supply of all types
of goods and services.
• Inflation is a purely monetary phenomenon and it is generally caused
by excessive money supply.
• Inflation is a post full employment phenomenon.
4. Reasons for inflation
• Demand-pull inflation: It is caused by an increase in the demand for the goods
and services which in turn increases their prices this is also known as too much
money chasing too few goods. If demand grows faster than supply, prices will
increase. This has been stated by the Keynesian school of economics.
• Measure: Import of goods is a short-term measure and as a long-term measure
government should increase the production to match the demand.
• Cost-push inflation: This is caused when the cost of production goes up. The
need to increase prices and maintain their profit margins results in the price
increase. This includes things such as wages taxes and increased cost of natural
resources or imports.
• Measure: Government should cut down taxes and reduce duties like excise and
custom on inputs as a short-term measure and in the long-term measure better
production process should be adopted.
5. • Monetary inflation: When there is an oversupply of money in the economy the
value of the money reduces and fewer goods can be bought with the same
money. So, if there is too much supply of the money price of the commodity
increases and results in inflation. This is stated by the monetarist school of
economics.
• Measure: In the short term a tighter monetary policy may be preferred and as a
long-term measure better production practices can resolve the issue.
7. Types of inflation
• Depending upon the range and severity there are several types of inflation.
• Moderate Inflation: The moderate inflation, also called as Creeping
Inflation refers to a single digit annual increase in the general price level.
when prices increases persistently, but at a mild or moderate rate, i.e. less than
10% or a single digit inflation rate.
• Galloping inflation: The galloping inflation refers to the exceptionally high inflation rate
that leads to an increase in the general price level. Generally, the inflation is in double or
triple digit and is reflected in the high price of goods and services, i.e. prices increase
manifold. The double-digit inflation varies from 10% to 999% per annum and there is a
great difference between these two limits. A country with 900% inflation will have more
devastating effects than the one having 20-30% inflation. This type of inflation is harmful
to the economy and it mostly affects the middle and lower income sectors.
8. • Hyperinflation: As the name suggests, the hyper inflation is the situation when
the prices rise at an alarmingly high rate, i.e. more than a three-digit per annum.
The prices rising above 1000% per annum marks the beginning of hyper inflation.
During this period, the paper currency becomes worthless, and people start trading
in kind, such as gold and silver and often resort to the old barter system of
commerce.
10. Positive Effect
• Increased Profits for Producers
• In most cases, inflation benefits the producers of goods. They make more money
because they can sell their products at higher prices.
• Increased Investment Returns
• During periods of inflation, investors and entrepreneurs are given additional
incentives to invest in productive activities. As a result, they benefit from higher
returns.
• Increase in production output
• When producers receive the appropriate investment, they produce more goods and
services. As a result, inflation causes an increase in product/service production.
• Increased Employment and Earnings
• As output rises, so does the demand for the various production factors, including
labor. As a result, employment and income rise in response to inflation.
11. • Shareholders income increases
• If a company's profits increase as a result of inflation, it can pay out
dividends to its shareholders. As a result, during inflationary periods,
shareholders' dividend income may increase.
• Borrowers' Advantages
• Inflation reduces the purchasing power of money. As a result, if the
borrower pays an interest rate that is lower than the inflation rate, he
benefits from the process. This is due to the fact that the real value of the
money returned by the borrower is less than the value of the money
borrowed.
• Governments tax revenue improves
• As the cost of goods and services rises, people must pay more indirect
taxes, and Direct taxes.
12. Negative Impacts
• Real-Income falls for groups with fixed income.
• People on fixed incomes, such as salaried workers, pensioners, and the like, will see a drop in real income. To
put it another way, their purchasing power will reduce.
• Income Distribution Inequality Rises
• Profits for business owners and entrepreneurs rise as a result of inflation. People in fixed-income groups, on the
other hand, see a decrease in their real income. As a result, income inequality becomes more pronounced during
this time period.
• Disturbs the Planning Process
• Inflation raises the prices of goods, raw materials, and factor services. As a result, the government must spend
more money to complete any investment project initiated during the planning period. If the government fails to
raise more financial resources through savings or taxation, the entire planning process is thrown off.
• Increased Speculative Investment
• Assume that prices are increasing at an alarming rate. People are unsure how much prices will rise in the
coming weeks or months. Many people begin speculative investments in such cases.
13. • Harmful Effects on Capital Accumulation
• If rising prices become chronic in an economy. During such periods, people
start preferring goods to money since the real value of money will fall in the
future. Also, people start preferring immediate consumption to consumption in
the future.
• Therefore, the general desire to save starts reducing. As the willingness and
ability to save reduces, the amount of funds available for further investment
reduces too. Therefore, the overall impact on the capital accumulation of the
economy is negative since capital accumulation in an economy depends on the
growth of investment.
• Lenders face Losses
• Borrowers benefit from inflation. Therefore, lenders stand a chance of losing
during such periods. This is because they receive an amount having lower
purchasing power than the amount loaned.
• Negative Impact on Export Income
• Since the prices of raw materials and factors of production increase, the prices
of export items also increase during inflation. Hence, their demand in the
foreign markets might fall which leads to a fall in the export income of the
country.
14. Indicators of inflation:
• The two most common indicators to measure inflation are wholesale
price index and consumer price index.
Wholesale price index:
• It is the price of a representative basket (697 items) of wholesale goods of 3
categories. manufacturing primary articles fuel and power. services are not
included in WPI.
• The data is released by the office of economic advisor, department of
industrial policy and promotion, ministry of Commerce.
• The base year for measuring WPI is 2011-12. The current series is
the 7th revision of the base year.
15. • Consumer price index:
• CPI measures the changes in the price level of a basket of consumer goods and services
or just by households
• It includes food and beverages housing fuel and light clothing and footwear pan,
tobacco and intoxicants.
• CPI is released in 3 categories. CPI rural, CPI urban, CPI combined
• Central statistics office, ministry of statistics and program implementation release the
data.
• Monetary policy takes note of CPI for inflation data.
Headline inflation
• Headline inflation is a measure of the total inflation within an economy including
commodities such as food and energy prices which are more volatile my core inflation
is calculated from CPI minus the volatile food and energy components. headline
inflation may not present an accurate picture of open economies inflationary trend.
16. Stagflation is high unemployment and economic stagnation along with high rates
of inflation. When the inflation rate is high the economic growth rate slows down,
and unemployment remains constantly high and results in stagflation.
Reflation: To achieve higher levels of economic growth and reduce unemployment
governments often go for stimulating the economy by increasing public
expenditure, tax cuts, lower interest rate etc. Here fiscal deficit rises due to
Stimulus, wages increase but there is no improvement in employment.
Phillips curve: Phillips curve explains the relationship between inflation and
unemployment in an economy according to the curve there is an inverse
relationship between inflation and unemployment.
Inflation targeting the announcement of an official target range by the central
bank for inflation is known as inflation targeting. it started in 2015 after the
agreement on monetary policy framework according to its CPI -C inflation to be
below 6% by 2016 January and 4% plus or minus 2% going forward.
Related terms
17. Is inflation always bad for the economy
• A simple definition of the inflation is the constant rise in the price of goods and
services. More often inflation is considered bad for any economy but this is just
half truth. The positive and negative impacts of inflation on the economy depend
on the rate of the inflation. Moderate inflation is good for the growth of the
economy while hyperinflation is injurious for it. The rate of inflation is
between 3 to 5%; it is beneficial for the economy and if it is beyond this range
it adversely affects the manufacturing sector in the country which further
squeezes the job opportunities and other opportunities.
18. MCQ
• Q. What is the Opposite of the term Deflation?
1.Stagflation
2.Inflation
3.Reflation
4.Disinflation
• Answer: Inflation
• Q. Who benefits from the increase in inflation?
1.Borrowers
2.Lenders
3.None
4.Importers
• Answer: Borrowers (Real interest rates decrease)
19. Q. Phillips curve is a measure of?
1.Stagnation and inflation
2.Higher wages and inflation
3.Unemployment and inflation
4.Higher wages and stagnation
Answer: Unemployment and inflation (There is an inverse relationship between
unemployment and inflation in a Phillips Curve)
Q. Fiscal Deficit is also known as?
4.Deflationary Gap
5.Inflationary Gap
6.Reflation
7.Primary Deficit
Answer: Inflationary Gap (Deflationary Gap is the Fiscal surplus)
