MEANING

 Inflation is a rise in the general level of prices

of goods and services in an economy over a
period of time.

Acc. to Prof. Samuelsons ”Inflation

occurs when general level of
prices and cost are rising”
Inflation and Deflation
A rising aggregate price level is inflation. Or an
Inflation is a continual rise in the price level
A falling aggregate price level is deflation.
The inflation rate is the annual percent change in
the aggregate price level.
The economy has price stability when the
aggregate price level is changing only slowly.
.
 Types of inflation

Moderate Inflation
It is a mild and tolerable form of inflation. It
occurs when prices are rising slowly .When
the rate of inflation is less than 10 per cent
annually, or it is a single digit inflation rate,
it is considered to be a moderate inflation in
the present the economy.
characteristics of moderate inflation

 There is a single digit inflation rate (less than 10 per

cent) annually& It does not disrupt the economic
balance.
iii. It is regarded as stable Inflation in which the relative
prices do not get far out of line.
iv. People’s expectations remain more or less stable
under moderate inflation
v. Under a low inflation rate, the real interest rate is not
too low or negative, so money can serve its role as a
store of value without difficulty. There are modest
inefficiencies associated with moderate inflation.
Creeping Inflation
 Inflation at moderate rates but persisting
over long periods.
 If inflation is rapid, it inflicts serious losses
and builds up strong political support for
measures to control it. for monetary
management
Galloping Inflation
 When the movement of price accelerates rapidly,
running inflation emerges ,a double digit inflation
of 10-20 per cent per annum is a running inflation.
If it exceeds that figure, it
may be called 'galloping' inflation. Its characteristics
are:
  1. Developing or progressing at an accelerated rate
2.  Galloping like a horse.
Galloping inflation is really a serious problem. It
causes economic distortions and disturbances.
 Hyperinflation

 Hyperinflation is inflation that is very high or "out of

control", a condition in which prices increase rapidly as
a currency loses its value Hyperinflation is the most
extreme inflation phenomenon, Hyperinflation is inflation
that exceeds 50 percent per month.
 The main cause of hyperinflation is a massive and
rapid increase in the amount of money that is not
supported by a corresponding growth in the output of
goods and services. This results in an imbalance
between the supply and demand for the money
(including currency and bank deposits), accompanied
by a complete loss of confidence in the money, similar
to a bank run
Features of Hyper inflation

 i. During hyperinflation, the price rise is

severe. The price index moves up by leaps
and bounds.
 ii. It represents the most pathetic
deterioration in people’s purchasing
power.
iii. Overall economic distortions take
place.
Inflation
The following photographs help illustrate how money can become worthless when
inflation gets out of control.

Title: Money Kite. Date: 1922. Description: A boy with a kite made of banknotes in Germany, during
the depression when escalating inflation rendered much currency worthless. Copyright: Getty Images,
available from Education Image Gallery (http://edina.ac.uk/eig/)
Inflation

Title: Overflowing Riches. Date: 1922. Description: A shopkeeper using a tea chest to store

money which won't fit in the cash register during Germany's high inflation. Copyright: Getty
Images, available from Education Image Gallery (http://edina.ac.uk/eig/)
Inflation

Title: The Value Of Money

Date: circa 1923
Description: Children using notes of
money as building blocks during the
1923 German inflation crisis.

Copyright: Getty Images, available

from Education Image Gallery
(http://edina.ac.uk/eig/)
Causes of inflation
 Demand pull
 Cost push
 Wage push
 Profit push
 DEMAND PULL

 It occurs when there is an excess of

demand for goods over their supply.
 Therefore any factor that increases
aggregate demand can cause inflation
Causes
 Growth in black money:- growth in an
unaccounted money leads to demand for
goods.
 Increase in population:-raises no. of
consumers.
 Increase in money supply:-raises money
circulation which in turn leads to demand
 Increase in disposable income of the
consumer.
 Increase in public expenditure.
Demand pull inflation
 As aggregate demand
increases then the general
price level rises
Demand pull inflation
 When total demand exceeds total supply
demand pull inflation occurs
 If the economy is close to full capacity
the effects of demand pull inflation will be
greater
Cost push inflation
 It occurs when rise in price is due to rise in cost
of production in this supply factor plays an
important role.
Causes:-
Higher taxes
An increase in the money wage rate
 An increase in the money price of raw
materials, such as oil.
Cost Push Inflation
 As costs rise it causes
the aggregate supply
curve to shift onwards so
less is supplied at each
price level
 Each time the aggregate
supply curve shifts
inwards the price rises
causing inflation
Wage push
 attempts to increase wages faster than
productivity .causes:-
Higher wage rate ,Often blamed on
unions
 Profit push
Defined as:
- attempts to increase profits by
raising prices
Causes:-
Higher profit margin
Often blamed on large
corporations
 REASONS FOR INFLATION
 lack of balance in the country’s budget
 financial problems, financeing the deficit of
money by printing
 Sudden increase in production costs
 significant increase in the level of energy
resources
 faulty structure of the economy
 Exported goods far exceeding imported ones
 too many monopolies in the economy
The Costs of Inflation
 Shoeleather costs
 Menu costs
 Relative price variability
 Tax distortions
 Confusion and inconvenience
 Arbitrary redistribution of wealth
Shoeleather Costs

 Shoeleather costs are the resources

wasted when inflation encourages people
to reduce their money holdings.
 Inflation reduces the real value of money,
so people have an incentive to minimize
their cash holdings.
Shoeleather Costs
 Less cash requires more frequent trips to
the bank to withdraw money from interest-
bearing accounts.
 The actual cost of reducing your money
holdings is the time and convenience you
must sacrifice to keep less money on
hand.
 Also, extra trips to the bank take time
away from productive activities.
Menu Costs
 Menu costs are the costs of adjusting
prices.
 During inflationary times, it is necessary to
update price lists and other posted prices.
 This is a resource-consuming process that
takes away from other productive
activities.
Relative-Price Variability

 Inflation distorts relative prices.

 Consumer decisions are distorted,
and markets are less able to allocate
resources to their best use.
Inflation-Induced Tax Distortion
 Inflation exaggerates the size of
capital gains and increases the tax
burden on this type of income.
 With progressive taxation, capital
gains are taxed more heavily.
Inflation-Induced Tax Distortion
 The income tax treats the nominal
interest earned on savings as income,
even though part of the nominal interest
rate merely compensates for inflation.
 The after-tax real interest rate falls,
making saving less attractive.
 Effects on production
Inflation has a favorable effect on production when there
are unutilized or under-employed resources in existence
in an economy .

Rising prices breed optimistic expectations within the

business community, in view of increasing profit margins,
because the price level moves up at a faster rate than the
cost of production.
Effects on Income distribution
Inflation redistributes income. Prices of all factors
do not rise in the same proportion. Since the effect
of inflation on the incomes of different classes of
earners varies, there are serious social
consequences.

During inflation, the distribution of shares to the

profiteers increases more than that of the wage
earners or fixed-income earners. All producers ,
traders and speculators gain during an inflation
because of the windfall profits which arise, because
prices rise at a faster and higher rate than the cost
of production.
 Effects on the consumption
and welfare
Inflation implies an erosion of the consumer’s value
of money. It is a form of taxation. Due to
deteriorating purchasing power the real
consumption of the common people declines.
Rising cost of living during inflation implies falling
standard of living and lowering of general economic
welfare of the community at large .

In short, inflation is unfair on the distribution of

side of economic activity.
Impact on balance of trade
 If 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
INFLATION AFFECTING
THE COMMON MAN
 Inflation affecting the common
man’s day to day savings
Inflation reduces the real amount of savings in the long
run. Common man is adversely affected when the
annual rate of inflation is exceeding the current rate of
interest. Continuous inflation also discourages the
individual savings of a common man .
Inflation widening the gap between
the rich and the poor
Inflation in a country creates a breeding ground for
social upheavals. Inflation re-distributes income
and wealth in favour of the rich, and widens the
gap between the rich and the poor . Inflation
favours the rich and the black marketers . The rich
and the business class get ample chances of
making profit through unfair means , while the poor
people indirectly suffer the social sins done by the
rich and the manipulating business class. Thus the
rich become richer and the poor become poorer
during inflation .
Dangers of inflation
 Rise in inequalities of income and
wealth :rich becomes richer and poor
becomes poorer .there is a
concentration of economic power in the
hands of rich people.
 Rise in black money: the new rich class
who suddenly become richer spends
their unaccounted money on luxury
goods and jewellery.
Measurement of Inflation
 A price index is a series of numbers
that summarizes what happens to a
weighted composite of prices of a
selection of goods (often called a market
basket of goods) over time.
Measurement of Inflation
 A price index can be created by looking
at a market basket of goods.
 Continued

 Loss of tax revenue:- tax authorities are

unable to track down money incomes in
various sectors of economy because
wage structure get distorted.
 Creditor are looser:-creditors stand to
loose as they get back lesser
purchasing power than what they lent.
How is inflation measured?
 WPI (Wholesale Price Index)
 India- the only major country that uses
WPI (1st published in 1902)
 What is WPI?
 The WPI number is a weekly measure of
wholesale price movement for the
economy
WPI- The Indian Example

 Indian government constructed its present

WPI way back in 1993-94 (1993-94 series
replacing 1981-82 bases) by making a
basket of 435 commodities
Major Groups:
 I. Primary Articles (98 items)- 22.02 %
 Food Articles, Non-Food Articles, Minerals
 II. Fuel, Power, Light & Lubricants (19 items)
- 14.23 %
 III. Manufactured Products (318 items)
- 63.75 %
 Food Products
 Beverages, Tobacco & Tobacco Products
 Textiles… etc
Consumer Price Index

Consumer Price Index (CPI): the CPI compares the

cost of a sample “market basket” of goods and
services in a specific period relative to the cost of
the same “market basket” in an earlier reference
period. This reference period is designated as the
base period.
The Consumer Price Index
(CPI)
 The consumer price index (CPI)
measures the prices of a fixed basket of
consumer goods, weighted according to
each component's share of an average
consumer's expenditures.
Composition of CPI, Fig. 6-7, p 153
The Consumer Price Index
(CPI)
 The CPI is the measure of inflation most
often presented in news reports.

 Many economists believe that the CPI as

currently constituted, overstates inflation
by one percentage point.
Inflation is unjust because it affects different classes of
people in the society in different ways and in different
degrees. If inflation were to affect everyone in the society
in exactly the same manner and to the same the degree, it
would not alter the economic and social relationships in
the community. But inflation takes away wealth from some
people and transfers it to others on a random basis
without taking into consideration the sound maxim of
social equality.