MB0042 MANAGERIAL ECONOMICS

Topics: Inflation, Economics, Supply and demand Pages: 14 (5177 words) Published: December 20, 2014

Question 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.

Define Inflation

Ans :- Inflation is the percentage change in the value of the Wholesale Price Index (WPI) on a year-on year basis. It effectively measures the change in the prices of a basket of goods and services in a year. In India, inflation is calculated by taking the WPI as base.

Formula for calculating Inflation=

(WPI in month of current year-WPI in same month of previous year) -------------------------------------------------------------------------------------- X 100 WPI in same month of previous year

Description: Inflation occurs due to an imbalance between demand and supply of money, changes in production and distribution cost or increase in taxes on products. When economy experiences inflation, i.e. when the price level of goods and services rises, the value of currency reduces. This means now each unit of currency buys fewer goods and services.

It has its worst impact on consumers. High prices of day-to-day goods make it difficult for consumers to afford even the basic commodities in life. This leaves them with no choice but to ask for higher incomes. Hence the government tries to keep inflation under control.

Contrary to its negative effects, a moderate level of inflation characterizes a good economy. An inflation rate of 2 or 3% is beneficial for an economy as it encourages people to buy more and borrow more, because during times of lower inflation, the level of interest rate also remains low. Hence the government as well as the central bank always strive to achieve a limited level of inflation.

Causes for Inflation
Ans :- Inflation is the devastating condition when prices just keep going up, eating away at your standard of living. There are three main causes: demand-pull, cost-push, and monetary expansion. Demand-Pull Inflation

Demand-pull inflation is the most common. It's simply when demand for a good or service increases so much that it outstrips supply. If sellers maintain the price, they will sell out. They soon realize now have the luxury of raising prices, creating inflation. Many circumstances can lead to demand-pull inflation. A growing economy can create some inflation as people feel confident about the future and spend more. As long as inflation stays within limits, this could actually benefit economic growth. That's because it creates an expectation of inflation, which can contribute to further demand-pull inflation. As people expect further inflation, they make their purchases sooner to avoid further price increases. The Federal Reserve has set an inflation target to manage the public's expectation of inflation. The inflation target is currently set at 2%, as measured by the core inflation rate. This removes the effect of seasonal food and energy increases. Discretionary fiscal policy contributes to demand-pull inflation. The government's ability to spend more or tax less increases demand in certain areas of the economy. Marketing and new technology can create demand-pull inflation for certain products or asset classes. For example, the Apple brand commands higher prices, a type of inflation, for its products. New technology, in the form of financial derivatives, created asset inflation in the housing market in 2005-2006. For more examples, see What Is Demand-Pull Inflation?. (Source: The St. Louis Federal Reserve, The Economic Lowdown; The Intelligent Economist, Demand-Pull Inflation) Cost-Push Inflation

A second cause of inflation is cost-push inflation. This isn't as common as demand-pull inflation, because it only occurs when there is a shortage of supply combined with enough demand to allow the producer to raise prices. Wage inflation can contribute to cost-push inflation....
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