Inflation

Sunil Kumar

Introduction
The fall in inflation rate helped Indian consumers, it had a negative impact on the economy. To minimize this negative impact, the RBI initiated various measures to increase money supply circulation in the economy. These measures aims at boosting aggregate demand.

Sunil Kumar

Types of Inflation

Creeping Inflation:
It leads to small increase in prices.

Running Inflation:
If creeping inflation continues for long period.

Hyper or Galloping Inflation:

When monetary authorities completely lose control over running inflation.

Sunil Kumar

Source of Inflation
Aggregate

Demand Aggregate Supply

Sunil Kumar

Aggregate Demand (AD)

Aggregate demand (AD) refers to collective behavior of all buyers in a market. AD curve has negative slope, because there is negative relation between price and output. The negative slope of AD is due to:

Real balance effect Foreign trade effect Interest rate effect

Sunil Kumar

Aggregate Supply (AS)

Aggregate supply is the real value of output producers are willing to and able to bring to market at alternative price levels. AS curve has upward slope due to:

Profit effect Cost effects

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Demand Pull Inflation

The general rise in the price level is because the demand for goods and services exceeds the supply available at existing prices. In this case AD curve shifts upward. It is due to:

The real factors

Increase in government expenditure

The monetary factors

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Demand Pull Inflation

Y
AS Price Level

P1 P0 AD1

AD0
O Y0 Y2 Y1 X
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Real OutputSunil Kumar

Cost Push Inflation

Cost push theory of inflation explains the causes of inflation origination from the supply side. Cost push inflation depends on:

Wage push inflation Profit push inflation Supply shock inflation

Sunil Kumar

Cost Push Inflation

Y
AS1 AS0 Price Level P1 P0

AD O Q1 Q0
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X
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Quantity

Measuring of Inflation

Variations in the price level are measured in terms of:

Wholesale Price Index (WPI) Consumer Price Index (CPI)

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Wholesale Price Index (WPI)

The WPI is an indicator designed to measure the changes in the price level of commodities that flow into the wholesale trade intermediaries. The index is a vital guide in economic analysis and policy formulation. In India, the wholesale pries are used to measure inflation. The Office of the Economic Adviser (OEA) in the Ministry of Industry. The duration is usually one or two week. It will not cover non-commodity producing sector.
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Calculation of WPI in India

For

each month, the arithmetic average price for each item in the market basket is derived first. The price relative or index for each commodity is then taken by dividing the computed arithmetic average price by the corresponding average base price as: PRi= (Pn i/P0i) x 100
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Calculation of WPI in India

The

index of the subgroup of the commodities is computed using the following formula: i i PRi= PRij /N The index of the next subgroup of commodities is computed by dividing the aggregate of weighted indices of component item in a subgroup by the total of their corresponding weights as: PRk=(PRjk x Wjk) / Wjk
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Calculation of WPI in India

The

overall index is computed using the following formula: I = (PRn x Wn) / Wn

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Consumer Price Index (CPI)

The consumer price index reflects the cost for living of a particular group in the population. CPI is measured on the basis of the changes in the retail prices of selected goods and services. There are several consumer price indices:

CPI-IW (for industrial workers) CPI-AL (for agricultural laborer) CPI-UNME (for urban non-manual employee)
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The Economic Impact of Inflation

Effect of inflation on the distribution of Income and Wealth

Debtors and Creditors Producers Investors

Effect of Inflation on Production

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Phillips Curve
The two variables that receive the most attention in macroeconomics are unemployment and inflation. Philips curve indicates the relation between inflation and unemployment rate. The Philips curve indicates a trade- off between inflation and unemployment.

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Philips Curve A TradeTrade-Off

P/P Y

Inflation 5 3 O

X
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Unemployment Sunil Kumar

Long Run Philips Curve No TradeTrade -Off

P/P Y
Long Run Phillips Curve

Inflation

I3 I2 I1 PC2 PC3 O U2 U1 U3 PC1

X
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Unemployment Sunil Kumar

Measures to Control Inflation

Monetary Measures Fiscal Measures

Public expenditure Taxation Public borrowing and debt

Other Measures
Price control and rationing Wage policy

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