FALL SESSION – 2014
MASTER OF BUSINESS ADMINISTRATION- SEMESTER 1
ROLL No. : 1408000472
Nitin Baban Borkar
MB 0042: Managerial Economics
Q.1. Inflation is a global Phenomenon which is associated with high price causes decline in the value for money. It exists when the amount of money in the country is in excess of the physical volume of goods and services. Explain the reasons for this monetary phenomenon.
Inflation is commonly understood as a situation of substantial and rapid increase in the level of prices and consequent deterioration in the value of money over a period of time. It refers to the average rise in the general level of prices and fall in the value of money. Inflation is an upward movement in the average level of prices. The opposite of inflation is deflation, a downward movement in the average level of prices. The common feature of inflation is rise in prices and the degree of inflation may be measured by price indices.
Inflation is statistically measured in terms of percentage increase in the price index, as a rate (percent) per unit of time- usually a year or a month. The trend of price indices reveals the course of inflation in the economy. Usually, the Wholesale Price Index (WPI) numbers are used to measure inflation. Alternatively, the Consumer Price Index (CPI) or the cost of living index can be adopted to measure the rate of inflation.
Causes of inflation
I. Demand side
Increase in aggregative effective demand is responsible for inflation. In this case, aggregate demand exceeds aggregate supply of goods and services. Demand rises much faster than supply. We can enumerate the following reasons for increase in effective demand.
~Increase in money supply – Supply of money in circulation increases on account of the following reasons: deficit financing by the government, expansion in public expenditure, expansion in bank credit and repayment of past debt by the government to the people, increase in legal tender money and public borrowing. * Increase in disposable income – Aggregate effective demand rises when disposable income of the people increases. Disposable income rises on account of the following reasons: reduction in the rates of taxes, increase in national income while tax level remains constant, and decline in the level of savings. * Increase in private consumption expenditure and investment expenditure – An increase in private expenditure both on consumption and on investment leads to emergence of excess demand in an economy. When business is prosperous, business expectations are optimistic and prices are rising. More investments are made by private entrepreneurs causing an increase in factor prices. When the income of the factors rise, there is more expenditure on consumer goods. * Increase in exports – An increase in the foreign demand for a country’s exports reduces the stock of goods available for home consumption. This creates shortages in the country leading to a rise in price level. * Existence of black money – The existence of black money in a country due to corruption, tax evasion, black-marketing, etc. increases the aggregate demand. People spend such unaccounted money extravagantly and create unnecessary demand for goods and services thus causing inflation. * Increase in foreign exchange reserves – This may increase on the account of inflow of foreign money into the country. Foreign direct investment may increase and non-resident deposits may also increase due to the policy of the government. * Increase in population growth – This creates an increase in demand for many types of goods and services in a country. * High rates – Higher rates of indirect taxes would lead to a rise in prices.
*Reduction in the rates of direct taxes – This would leave more cash in the hands of people inducing them to buy more goods and services leading to an increase in prices. * Reduction in the level of savings – This creates more demand for goods and...
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