Impact of Inflation

Pages: 10 (3646 words) Published: December 20, 2012
Format
Introduction
What is inflation?
Measurement of Inflation
Causes and theories of inflation
Types of inflation
Effects of inflation
Fiscal policy
Monetary policy
Last two years in India
Issues:-
1-Inflation in different sectors
Factors-
1-supply constraints
2- demand pressures
3- domestic factors
Effects of inflation-
Conclusion (with future perspective)

Inflation
A persistent rise in prices in an economy over a period of time is referred to as inflation. Inflation or rate of inflation is the percentage change in overall price level from one year to the next year. Inflation is an outcome of one of the types of disturbances in goods market, which has something called aggregate demand (AD) and aggregate supply (AS). When AD > AS, then the price of the good increases and it is called inflation. During inflation, it is very much possible that the prices of some goods may fall, but the overall trend of the prices is upward. Measurement of Inflation: The rate of change in the general price per year is expressed in percentages. The simple inflation rate in period t (Pt) over the last one year (Pt-1) is given by {(Pt – Pt-1) / Pt-1} * 100, here Pt and Pt-1 are 52 week average of WPI in a particular year and the year before that. The above formula is used when the compounding is done once in an year. If compounding is done on a continuous basis then Pt = ln (Pt / Pt-1)

There are some price indices which are used to calculate inflation. A Price index refers to weighted average of the price of a basket of goods and services. In constructing price indexes, a weight of individual prices of each good is taken into account based on its economic importance (its relative importance in consumer expenditure budgets). Important price indices used are Consumer price index (CPI), GDP price index, Producer price index (PPI) and Wholesale price index (WPI). Of the indices mentioned above WPI is the most widely used measure in India. The reasons are 1) Absence of any harmonized CPI in India.CPI are calculated for different segments of people separately and do not cover the entire population.

2) Frequency of data availability – WPI is a weekly measure unlike the CPIs which are monthly indices. 3) Adding to this, the consumer in the Indian context is very diversely spread in every sense of the term. As a result, data collection is practically impossible. This is a weekly measure which is compiled by the Office of economic advisor, Ministry of Commerce and Industry. Understanding Inflation and Controlling It: Kaushik Basu

Types of Inflation:
We can broadly categorize inflation into two categories:
1. Demand Pull Inflation: This type happens when spending on goods and services are causing the prices to rise. The major factor behind the demand pull inflation is the rise in consumption by the citizens of a country. If the government responds in such a situation by increasing the money supply, the demand pull inflation becomes worse and this may lead to Hyperinflation which has no fixed rate of increase of prices but is said to occur when inflation touches a monthly rate of 50% or more. 2. Cost Push Inflation: This happens when the prices of factors of production rises in economy. The increase in the cost of production for a producer reduces his ability to produce and causes unemployment in the economy. So now the inflation is coupled with unemployment. This type of scenario is also called Stagflation. The threat of stagflation is increased when the economy is under a recession when GDP is slumping and unemployment is high. The best way to come out the scenario is to avoid allowing too much money to enter the economy too quickly as quoted by Economist and Nobel laureate Milton Friedman that "Too much money chasing too few goods." Effects of Inflation:

There are two parties who are affected by inflation. One of them benefits from inflation and other loses...