Download Chapter 5 - Consumer Choice

Inflation
Chapter 3
Macro Economics
Chapter #3
• Overview
•
Inflation
1.
2.
3.
4.
5.
Meaning and concept of Inflation
Kinds of Inflation
Causes of Inflation
Inflation rates
Control over Inflation
6. Effects of Inflation
7. Future Forecasting on the basis of
inflation.
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Inflation
A process of rising prices OR
persistent rise in the general price
level in a country over a period of
time is called inflation.
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Kinds of Inflation
•
•
•
•
Cost push
demand pull inflation
Suppressed inflation
Stagflation
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Cost push Inflation
Cost push inflation: It is a situation where a rise in the
general price level is initiated and sustained by rising
cost due to which prices go up.
For example: when the cost of raw material goes up the price of
goods also go up which leads to inflation. That’s call cost push
inflation. Simply we can say when the price of factor of production
increase it increase the prices of goods and services. Factor of
production (land, Labor, Capital and Enterprise).
When
C
and
P is called Cost Push Inflation.
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Demand pull Inflation
• Demand pull inflation: It is a situation where
the aggregate demand persistently exceeds the
available supply of output at a current prices
which once again causes the general price
level to go up.
• For example: The demand is high in the market but supply
is less so due to which the sellers increase the price of
products.
• When
D and
S it lead inflation.
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Suppressed Inflation
This is a temporary measure of preventing inflation but
eventually leads to inflation. the government fixes
the prices of basic essentials like agriculture products
very much below the equilibrium price. This is
suppressed inflation i.e suppressed through price
control.
it means gov. don't let the sellers to sell goods with high prices and
gov. fixes the price
what the sellers do they stock the goods and sell it in black market
and when this policy of gov. finishes the price goes very high
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Stagflation
This is a combination of two words i.e.
stagnation (unemployment) of the economy
and inflation in the economy.
Stagflation is a situation where both
unemployment and the rate of inflation are
higher as compared to the accepted
standard. Which lead inflation.
Accepted standard every country has there
own standard for employment and inflation.
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Causes of Inflation
• Policy of deficit financing: some time the Govt implement new
taxes on commodities or borrow loans from other countries to
cover their losses due to which inflation occur in a country.
• Backwardness of agricultural and industrial sector of the
economy:
• Devaluation of currency: when a country currency start
devaluation due to which it loss purchasing power. So the prices of
commodities increase.
• Political instability: Private sector does not get involved in the
production.
• Undesirable activities: like black marketing, smuggling etc. (the
shortage of supply leads to inflation)
• Growth of population: when population of a country start increase
it also lead inflation.
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Inflation rates
• It is a particular rate at which the level of inflation in
the economy is measured or evaluated in a specific
time period.
• Such rate is found by the given following formula…
Inflation rate = current price level – previous price level
previous price level
X 100
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Calculation of inflation
• The basket contains 20 pizzas and 10
compact discs.
Prices
Year
Pizza
CDs
2001
$10
$15
2002
$11
$15
2003
$12
$16
2004
$13
$15
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Continue
• For each year, compute
• the cost of the basket. Total Cost of
production
• the CPI (use 2001 as the base year)
• the inflation rate from the preceding year.
CPI= Cost of basket in current year
Cost of basket in base year
X 100
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Continue
Prices
year Pizz
a
CDs
Cost of basket
CPI
Inflation Rate
200
1
10
15
(20×10)+(10×15)
= 350
350/350×100
= 100
-----
200
2
11
15
(20×11)+(10×15)
= 370
370/350×100
= 105.7
{(105.7-100)/100}×100
= 5.7%
200
3
12
16
(20×12)+(10×16)
= 400
400/350×100
= 114.3
{(114.3-105.7)/105.7}×100
= 8.13%
200
4
13
15
(20×13)+(10×15)
= 410
410/350×100
= 117.1
{(117.1-114.3)/114.3}×100
= 2.5%
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Inflation Based on Rates
• Creeping inflation.
A situation in which the rise In
general price level is at a very slow
rate up to 2%.
• Walking inflation.
A situation in which the rise in
price level in around 5%
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Cont`d
• Running inflation.
In this type of inflation the price
rises from 8 to 10%.
• Hyper inflation.
This is known as final stage of
inflation where the prices go up
very high from 10 % to onward
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Control over Inflation
• Inflation can be controlled by
three sorts of Policies…
• Fiscal Policy.
• Monetary policy.
• Direct measure.
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Fiscal Policy:
Fiscal Policy: which refers to the
government policy of public expenditure
and taxes, can be used an anti-inflationary
measure. The government reduces its
expenditure on unproductive activities. It
raises direct taxes which decrease
disposable income of the consumers and
due to direct taxes aggregate demand of
goods falls down.
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Monetary Policy:
• Monetary Policy:
 Raising bank rates: bank increase interest rate on
deposit due to which people deposit their money in
banks and purchasing power of the people decrease
due to which inflation control.
 Varying reserve ratio: the central bank change the
reserve ratio. Mean central bank increase reserve ratio
to all commercial banks due to which major portion
of money goes to central bank and commercial banks
can not issues
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3) Direct Measures
Direct Measures: The government regulatory
authority play an important role. For
example ministry of labor fix wages and
salaries for employees. Same the
government fix the prices of different
commodities to control inflation in the
country.
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Effects of Inflation
Inflation has both positive and negative effects
for the economy. But mostly harmful effects
are greater than positive effects.
Harmful Effects of Inflation:
1) Increase in cost of living: The working
classes are hard hit. Wages and salaries do
not rise at that rate as prices are rising. Those
section of society who have fixed incomes,
find difficulty in buying their daily needs.
20
Conti
2) Income inequalities increase: when prices are rising
and businessmen and big landlords make huge
money. The distribution of income among various
classes of society becomes more unequal. Due to
which the position of wage earners become weaker.
They get a smaller share of national income and the
rich-poor gape increase.
3) Decrease in Saving: during rising prices the saving of
common people are adversely affected. Greater part
of their incomes is used to buy consumer goods.
21
Conti
4) Less export and more import: due to
inflation local goods become costly for
the foreigners means for other country
people. They start buying from other
countries. It effect our export and the
graph of import increase.
5) Productive investment falls: due to
inflation cost of production increase.
Which affect the sale of the product.
And local producer face greater lose.
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Conti
Good effects: healthy effects of inflation on the
economy are felt only when the inflation rate
is up to 2 % per year.
1)Increase in production: when prices are rising
slowly, the profits of the industrialist and
businessmen rise. They try to produce more
good for more profit.
2) Increase in Employment: Because of high
prices of products, firms try to increase
production and employ more workers.
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Conti
3) Increase in Investment: when prices increase
the investor increase their investment in
business to earn more profit.
4) Increase in Economic Development: low
inflation is helpful for economic development.
The government increase resources by
increasing money supply. When government
print more money they use it for more
development in the country.
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Future forecasting on the
basis of inflation rate.
To find out the cost of a product for future
on the basis of inflation rate we use the
following formula.
n
Fv= pv (1+i)
Fv= future value
Pv= Present value
i= rate of inflation
n= number of year
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Conti
Suppose the cost of a house is 20000, if we
purchase it today. If there is 5% inflation ,
how much we will pay after 4 years for the
same house.
Fv= 20000(1+.05) 4
= 20000(1.21551)
=24310
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End of chapter
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