INFLATION

In economics, generally inflation is a constant increase in price of goods

and services over a period of time. When the price level rises, each unit
of currency buys fewer goods and services. Hence, inflation reduces the
purchasing power per unit of money. A chief measure of price inflation is
the inflation rate, the annualized percentage change in a general price
index. Lets say if inflation goes up by 3% then there is a decline in the
purchasing power of money. In this case pack of gum costing Rs 100 will
cost Rs 103 in a year. So we cant purchase same quantity with Rs 100
post inflation.
Types of Inflation
Demand-pull or excess demand: This is important type of inflation. It
occurs when the total demand for goods and services in an economy
exceeds the available supply, so the prices for them rise in a market
economy. This has been the most common type of inflation and is the
most serious. Every time of emergency causes this type of inflation
because demand for war materials and manpower grows rapidly without
comparable shrinkage elsewhere.
Cost-push inflation: This is second type of inflation. As the name
suggests the cause--costs of production rise, for one reason or another,
resultant force up the prices of finished goods and services. Rise in
labour cost in excess of any gains in labour productivity is what raises
costs of production and thus raises prices. It can occur independently as
well as in conjunction with it.
Pricing power inflation: This type of inflation occurs whenever
businesses in general decide to increase their prices to boost their profit
margins. This occurs normally when the economy is booming and sales
are strong. It also can be termed as oligopolistic inflation, as it
oligopolies that have the power to set their own prices and raise them
whenever they decide the time is favourable.
.
Sectoral inflation: This is the fourth type of inflation. This happens
when the different raw material price rise, the price of the finished
product of various other sectors also rise leading to Sectoral inflation.
For example steel or oil, that raises costs of the industries using say

steel or oil, and forces up prices there also, so inflation becomes more
widespread throughout the economy, although it originated in just one
basic sector.

Causes of Inflation
Lets discuss the exact causes of inflation in an economy. There is not
concrete answer of this but some of the major are:
The Money Supply
Inflation is primarily caused by an increase in the money supply in the
market that speeds up the economic growth. Post gold standard during
the past century, the value of money is determined by the amount of
currency that is in circulation. When the government pump in more
money than actual growth so as a result, this devaluation will force
prices to rise due to the fact that each unit of currency is now worth less.
If the quantity of a specific item is less, the more valuable it must be. The
same logic works for currency; the less currency there is in the money
supply, the more valuable that currency will be.
The National Debt
If the countrys debt increases then this is not a good symbol. There are
two ways to cope up with this. Either government can raise tax by
putting burden to people or by printing more currency. A rise in taxes will
cause businesses to raise their prices to offset the increased corporate
tax rate. Alternatively, should the government choose the latter option,
printing more money will lead directly to an increase in the money
supply, which will in turn lead to the inflation as discussed earlier.
Demand-Pull Effect
It states that as salaries increase within an economic system due to
growing economy or increasing employment rate the people will have
more money to spend on consumer goods. This will increase the
demand of the consumer products, when this demand increases the
companies will raise the prises to the level to balance the demand and
supply. So this raises the prices and inflation.
A good example would when hourly wages increase, many people may
determine to undertake home improvement projects like house
renovation, interiors change. This increased demand for home
improvement goods and services will result in price increases by housepainters, electricians, and other general contractors in order to offset the
increased demand. This will in turn drive up prices across the board.

Cost-Push Effect
This states that when companies are purchasing raw material, goods
and labour at increased rate, to maintain their profitability they pass this
increased cost of production to the consumer in the form of higher
prices.
A simple example would be an increase in diesel prices, which would
undoubtedly drive up the price of a local transport and ferry costs of
material.
Exchange Rates
This is important factor that contribute in Inflation. Inflation can be made
worse by our increasing exposure to foreign marketplaces. We dont
care about exchange rate in our day to day life but it matter most in
foreign market. Change in forex rate is a major factor in increasing or
decreasing inflation. For ex if the exchange rate suffers such that the
U.S. currency has become less valuable relative to foreign currency, this
makes foreign commodities and goods more expensive to American
consumers while simultaneously making U.S. goods, services, and
exports cheaper to consumers overseas.

Effects of Inflation

General effects
If price increase then purchasing power of that currency decreases. That
is, when the prices rise, each unit of money buys fewer goods and
services. The effect of inflation is not distributed evenly in the economy,
and as a consequence there are hidden costs to some and benefits to
others from this decrease in the purchasing power of money. For
example, with rise of inflation, persons which own assets such as
property, stock etc., benefit as their value of their holdings going up,
when those who wants to purchase them will need to pay more for them.
Their ability to do so will depend on the degree to which their income is
fixed. Generally increases in payments to workers and pensioners often
less than inflation and for some people income is fixed. Other example
would be when the inflation rate is 4% a loan with a nominal interest rate
of 6% would have a real interest rate of approximately 2%. Any
unexpected increase in the inflation rate would decrease the real interest
rate. Banks and other lenders adjust for this inflation risk either by

including an inflation risk premium to fixed interest rate loans, or lending

at an adjustable rate.
Negative effects
High inflation rates are always regarded as harmful to an overall
economy. It makes companies difficult to budget or plan for long-term.
Inflation can force companies to shift resources away from services and
product to retain profit and reduce losses. Inflation can also impose
hidden tax increases. With high inflation, purchasing power is
redistributed from those on fixed nominal incomes, such as some
pensioners whose pensions are fixed, towards those with variable
incomes whose earnings may better keep pace with the inflation. There
can also be negative impacts to trade from an increased instability in
currency exchange prices caused by unpredictable inflation.
Cost-push inflation
It is a type of negative effect. As high inflation can prompt employees to
demand high wage increases, this in turns again add fuel to inflation and
more price rise. This is called cost push inflation.
Positive effects
Moderate inflation enables adjustment of wages
With inflation the real wages falls but the nominal wages remain
constant. So little inflation help labour market to reach equilibrium faster.
Room to maneuver
A moderate level of inflation tends to ensure that nominal interest rates
stay sufficiently above zero so that if the need arises the bank can cut
the nominal interest rate.
Inflation can boost growth
At times of very low inflation the economy may be stuck in a recession.
Arguably targeting a higher rate of inflation can enable a boost in
economic growth.
Financial market inefficiency with deflation
During a prolonged period of deflation and very low inflation, the
economy can suffered lower growth. When prices are falling people are
reluctant to spend money because they are concerned that prices will be
cheaper in the future, therefore, they keep delaying purchases. Also,
deflation increases the real value of debt and reduces the disposable
income of individuals who are struggling to pay off their debt.

How to measure inflation:

Inflation is measured through CPI means Consumer Price Index. The
inflation rate is the percentage rate of change of a price index over time.
To illustrate the method of calculation, in January 2008, the Consumer
Price Index was 202.416, and in January 2009 it was 211.080. The
formula for calculating the annual percentage rate inflation in the CPI
over the course of the year is:
{(211.080 202.416) / 202.416 } X 100 % = 4.28 %
The resulting inflation rate for the CPI in this one year period is 4.28%,
meaning the general level of prices for typical consumers rose by
approximately four percent in 2008.
Other common measure of inflation is GDP Deflator. It is a measure of
the price of all the goods and services included in gross domestic
product (GDP).
GDP Deflator = NominalGDP / RealGDP

Methods to Control Inflation

Increase interest rates:
The Central bank could increase interest rates. Higher rates make
borrowing more expensive and promote more savings. This should lead
to lower growth in consumer spending and investment.
Fiscal Policy
The government can cut spending by increase vat and income taxes.
This improves the budget situation and helps to reduce demand in the
economy.
Wage Control
If inflation is caused by raising wages then controlling salaries can help
to limit inflation. Limited wage growth helps to reduce cost push inflation,
and helps to moderate demand pull inflation.

Monetarism
Monetarism means limited money supply. There is a strong link between
the money supply and inflation. If you can control the growth of the
money supply, then you should be able to bring inflation under control.
Supply Side Policies
Often inflation is caused by non competitive environment and rising
costs. These types of policies may enable the economy to become more
competitive and help to moderate inflationary pressures.
Conclusion:
So finally we have discussed about inflation its positive and negative
side and also how to control it to some extent. Inflation effect everybody
life in either positive or negative way. It is a serious problem and needs
to tackle carefully if it is crossing limit.