04/08/2023 12:18 PM 1

Inflation in india

Inflation in india

Ghanshyam iilm gurgaon

04/08/2023 12:18 PMGhanshyam iilm gurgaon 2

INFLATION “Inflation is nothing more than a sharp

upward rise in price level.” Too much money chasing, too few

goods.” Inflation is a state in which the value of

money is falling i.e. price are rising.”

04/08/2023 12:18 PMGhanshyam iilm gurgaon 3

KINDS OF INFLATION

On the basis of rate of inflation On the basis of degree of control On the basis of causes Others

04/08/2023 12:18 PMGhanshyam iilm gurgaon 4

CAUSES OF INFLATION

Cost push inflation Demand pull inflation

04/08/2023 12:18 PMGhanshyam iilm gurgaon 5

Cost push inflation

Cost push inflation may arise because of :

a) Increase in money prices of raw materials.

04/08/2023 12:18 PMGhanshyam iilm gurgaon 6

Cost push inflation When there is a decrease in the aggregate supply of

goods and services stemming from an increase in the cost of production, we have cost-push inflation.

   Cost-push inflation basically means that prices have

been “pushed up” by increases in costs of any of the four factors of production (labor, capital, land or entrepreneurship) when companies are already running at full production capacity.

With higher production costs and productivity maximized, companies cannot maintain profit margins by producing the same amounts of goods and services. As a result, the increased costs are passed on to consumers, causing a rise in the general price level (inflation).  

04/08/2023 12:18 PMGhanshyam iilm gurgaon 7

Cost push inflation To visualize how cost-push inflation works, we

can use a simple price-quantity graph showing what happens to shifts in aggregate supply. The graph below shows the level of output that can be achieved at each price level. As production costs increase, aggregate supply decreases from AS1 to AS2 (given production is at full capacity), causing an increase in the price level from P1 to P2. The rationale behind this increase is that, for companies to maintain (or increase) profit margins, they will need to raise the retail price paid by consumers, thereby causing inflation

04/08/2023 12:18 PMGhanshyam iilm gurgaon 8

Cost push inflation

04/08/2023 12:18 PMGhanshyam iilm gurgaon 9

Demand pull inflation

Demand pull inflation may be due to :

a) Increase in money supplyb) Increase in government purchasesc) Increase in exports

04/08/2023 12:18 PMGhanshyam iilm gurgaon 10

Demand Pull Inflation

Demand-pull inflation occurs when there is an increase in aggregate demand, categorized by the four sections of the macroeconomy: households, businesses, governments and foreign buyers.

When these four sectors concurrently want to purchase more output than the economy can produce, they compete to purchase limited amounts of goods and services.

Buyers in essence “bid prices up”, again, causing inflation. This excessive demand, also referred to as “too much money chasing too few goods”, usually occurs in an expanding economy.  

04/08/2023 12:18 PMGhanshyam iilm gurgaon 11

Demand Pull Inflation

As companies increase production due to increased demand, the cost to produce each additional output increases, as represented by the change from P1 to P2.

The rationale behind this change is that companies would need to pay workers more money (e.g. overtime) and/or invest in additional equipment to keep up with demand, thereby increasing the cost of production.

Just like cost-push inflation, demand-pull inflation can occur as companies, to maintain profit levels, pass on the higher cost of production to consumers’ prices.

04/08/2023 12:18 PMGhanshyam iilm gurgaon 12

Demand Pull Inflation

04/08/2023 12:18 PMGhanshyam iilm gurgaon 13

HOW TO CONTROL INFLATION

Monetary Measures Fiscal Measures Other Measures

04/08/2023 12:18 PMGhanshyam iilm gurgaon 14

Monetary Measures

Credit Control Demonetization of Currency

04/08/2023 12:18 PMGhanshyam iilm gurgaon 15

Fiscal Measures Reduction in Unnecessary Expenditure Increase in Taxes Increase in Savings Surplus Budgets Public Debt

04/08/2023 12:18 PMGhanshyam iilm gurgaon 16

OTHER MEASURES To Increase Production Rational Wage Policy Price Control

04/08/2023 12:18 PMGhanshyam iilm gurgaon 17

How is it Measured?

Consumer Price Index Wholesale Price Index

04/08/2023 12:18 PMGhanshyam iilm gurgaon 18

Consumer Price Index

CPI is a measure estimating the average price of consumer goods and services purchased by households.

CPI measures a price change for a constant market basket of goods and services from one period to the next within the same area (city, region, or nation).

It is a price index determined by measuring the price of a standard group of goods meant to represent the typical market basket of a typical urban consumer. The percent change in the CPI is a measure estimating inflation.

04/08/2023 12:18 PMGhanshyam iilm gurgaon 19

Wholesale Price Index

WPI was published in 1902,and was one of the economic indicators available to policy makers until it was replaced by most developed countries by the CPI market. index in the 1970.

WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market.

Some countries (like India and The Philippines) use WPI changes as a central measure of inflation. However, India and the United States now report a producer price index instead.

04/08/2023 12:18 PMGhanshyam iilm gurgaon 20

EFFECTS OF INFLATION

They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term.

Uncertainty about the future purchasing power of money discourages investment and saving.

04/08/2023 12:18 PMGhanshyam iilm gurgaon 21

EFFECTS OF INFLATION

There can also be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable inflation.

Higher income tax rates. Inflation rate in the economy is higher

than rates in other countries; this will increase imports and reduce exports, leading to a deficit in the balance of trade.

04/08/2023 12:18 PMGhanshyam iilm gurgaon 22

EXAMPLE

Increase in the price of wheat Increase in the price of world oil Increase in the price of rice Increase in the price of CNG

04/08/2023 12:18 PMGhanshyam iilm gurgaon 23

Stagflation

A condition of slow economic growth and relatively high unemployment accompanied by inflation.

This happened to a great extent during the 1970s, when world oil prices rose dramatically, fueling sharp inflation in developed countries.

04/08/2023 12:18 PMGhanshyam iilm gurgaon 24

Phillips Curve

In 1958, a New Zealand economist , A.W.H. Phillips proposed that there was a trade-off between inflation and unemployment.

The lower the unemployment rate, the higher was the rate of inflation.

Governments simply had to choose the right balance between the two evils.

Economies did seem to work like this in the 1950s and 1960s, but then the relationship broke down.

The Philips Curve

The Phillips Curve

1958 – Professor A.W. Phillips Expressed a statistical relationship

between the rate of growth of money wages and unemployment from 1861 – 1957

Rate of growth of money wages linked to inflationary pressure

Led to a theory expressing a trade-off between inflation and unemployment

The Phillips CurveWage growth % (Inflation)

Unemployment (%)

The Phillips Curve shows an inverse relationship between inflation and unemployment. It suggested that if governments wanted to reduce unemployment it had to accept higher inflation as a trade-off.

Money illusion – wage rates rising but individuals not factoring in inflation on real wage rates.

1.5%

6%4%

2.5%

PC1

The Phillips Curve

Problems: 1970s – Inflation

and unemployment rising at the same time – stagflation

Phillips Curve redundant? Or was it moving?

The Phillips CurveWage growth % (Inflation)

Unemployment (%)

An inward shift of the Phillips Curve would result in lower unemployment levels associated with higher inflation.

1.5%

6%4%PC1

3.0%

PC2

The Phillips CurveInflation

Unemployment

Long Run PC

PC1

PC2PC3

Assume the economy starts with an inflation rate of 1% but very high unemployment at 7%. Government takes measures to reduce unemployment by an expansionary fiscal policy that pushes AD to the right (see the AD/AS diagram on slide 15)

7%

2.0%

1.0%

There is a short term fall in unemployment but at a cost of higher inflation. Individuals now base their wage negotiations on expectations of higher inflation in the next period. If higher wages are granted then firms costs rise – they start to shed labour and unemployment creeps back up to 7% again.

3.0%

To counter the rise in unemployment, government once again injects resources into the economy – the result is a short-term fall in unemployment but higher inflation. This higher inflation fuels further expectation of higher inflation and so the process continues. The long run Phillips Curve is vertical at the natural rate of unemployment. This is how economists have explained the movements in the Phillips Curve and it is termed the Expectations Augmented Phillips Curve.

The Phillips Curve

Where the long run Phillips Curve cuts the horizontal axis would be the rate of unemployment at which inflation was constant – the so-called Non-Accelerating Inflation Rate of Unemployment (NAIRU)

The Phillips Curve

To reduce unemployment to below the natural rate would necessitate:

1. Influencing expectations – persuading individuals that inflation was going to fall

2. Boosting the supply side of the economy - increase capacity (pushing the PC curve outwards)

The Phillips Curve

Supply side policies have been focused on: Education:

› Boosting the number of those staying on at school› Boosting numbers going to university› Lifelong learning› Vocational education

Welfare benefits:› The working family tax credit› Incentives to work

Labour market flexibility

04/08/2023 12:18 PMGhanshyam iilm gurgaon 34

End

Thank You