INFLATION (DETAIL)

INFLATION

Concept of inflation

Inflation is defined as a persistent rise in the general price level. During inflation, the purchasing power of money falls because there is an inverse relationship between the general price level and the value of money.

According to Gardner Ackley, “Inflation is a persistent and appreciable rise in the price level.”

According to Crowther, “ Inflation is the state in which the value of money is falling, I.e, the prices of money are rising.”

So, we can conclude that inflation is the rise in the overall level of prices or a fall in the value of money in the economy.

FEATURES OF INFLATION

1. Inflation is the real rise in the general price level.

2. It is a monetary phenomenon generally caused by an excessive money supply.

3. It is not a temporary fluctuation but a sustained rise in the price level.

4. It is a dynamic process that is observed for a long period.

5. Inflation is not the increase in the individual price but the increase in the general price level. 

TYPES OF INFLATION

A. ON THE BASIS OF SPEED

1. CREEPING INFLATION

If the annual rate of inflation is up to 3 %, it is called creeping inflation.

2. WALKING INFLATION

If the annual rate of inflation is more than 3% and less than 9%, then it is called walking inflation.

3. RUNNING INFLATION

If the annual rate of inflation is more than 9% and less than 20 %, then it is called running inflation.

4. HYPER/ GALLOPING INFLATION

If the annual rate of inflation is more than 20%, then it is called hyperinflation. There is no upper limit to hyperinflation.

B. ON THE BASIS OF CAUSE

1. DEMAND-PULL INFLATION

Demand-pull inflation is defined as the inflation which occurs due to the excess aggregate demand in an economy. It is also known as excess demand inflation.

2. COST-PUSH INFLATION

Cost-push inflation is defined as the inflation which occurs due to the rise in the cost of production or the rise in the price of inputs.

CAUSES OF INFLATION

1. DEMAND-PULL INFLATION

When the aggregate demand for goods and services exceeds the total supply of goods and services in an economy, the general price rises which is known as demand full inflation. In this type of inflation, the demand pulls up to the prices. The causes of demand-pull inflation are as follows:-

A. INCREASE IN MONEY SUPPLY AND BANK CREDIT

When the money supply increases, the rate of interest falls, then consumption and investment expenditure will increase. This leads to an increase in the demand which increases the price level.

B. INCREASE IN PUBLIC EXPENDITURE

If the government spends more than its revenue, there will be an expansion of the money and inflation occurs.

C. INCREASE IN PRIVATE EXPENDITURE

The increase in private expenditure in investment and consumption causes excess demand in the economy which results in inflation.

D. REDUCTION IN TAXATION

If the government reduces the rate of direct taxes, the purchasing power of people will increase, which causes excess demand resulting in inflation.

E. OTHERS

I.Increase in export

ii. Repayment of past internal debts

iii. The rapid growth of population

2. COST-PUSH INFLATION

When the cost of production increases, the general price level rises which is known as the cost-push inflation.The cost of production increases due to the rise in the price of a factor of production. The causes of cost-push inflation are as follows:

1. INCREASE IN WAGES

In the modern days, trade unions have become very strong and secured higher wages for their members. This increases the cost of production and to maximize the profits, the business persons raise the prices of their products. It is also known as wage push inflation.

2. INCREASE IN THE PRICES OF KEY MATERIALS

Cost-push inflation is caused by an increase in the price of key materials like raw materials, basic chemicals, petroleum, etc. This type of inflation is also known as material push inflation.

3. INCREASE IN PROFIT MARGINS

Inflation also occurs due to the organized efforts of the sellers to increase the profit margin. It is also known as profit push inflation.

CONSEQUENCES/ EFFECTS OF INFLATION

1. EFFECTS ON PRODUCTION

The mild rate of inflation has positive effects on the economy because it stimulates the production and increases the profit margin. But, hyperinflation adversely affects the production activities in the economy.

2. REDUCES SAVING AND CAPITAL FORMATION

Inflation causes a decline in the value of money which increases expenditure. Consequently, saving decreases which reduces capital formation.

3. CHANGE IN STRUCTURE OF PRODUCTION

Because of inflation, there will be a shift of resources from the production of necessary goods to the luxuries which have higher prices. This creates a shortage of necessary goods.

4. DECLINE IN THE QUALITY OF PRODUCTS

During inflation, business persons can sell any kind of commodity because of the excessive demand. In such a case the producers do not care for the quality.

5. EFFECTS ON ECONOMIC GROWTH

Inflation discourages savings and reduces both domestic and foreign investment. The productivity will decline and the economic growth of the country will be slow.

6. EFFECTS ON EMPLOYMENT

The mild inflation has positive effects on investment and employment. But hyperinflation will have a negative effect on employment because it reduces saving, investment, capital formation, and output in the economy.

7. OTHERS

A. Encourage hoarding of commodities

B. Discourages foreign capital

C. Effects on distribution

D. Social effect

E. Moral effects

F. Political effect