Inflation Session No. 19

Macroeconomics & Business Environment

19

Price Stability PREPARED BY:

Pyare Lal Verma, Faculty Economics/QM, INC Shimla

Session

19

1.

Understand about Inflation and how to measure inflation.

3.

To understand about the economic impact of Inflation

5.

To understand inflation in AD-AS Framework

7.

To distinguish between a) Demand-Pull Inflation; b) Cost-Push Inflation.

Session

19

19.1

Inflation

a) Inflation can be defined as a rise in the general price level and therefore a fall in the value of money. b) inflation can be measured in terms of percentages. The percentage increase in the price index, as a rate per cent per unit of time, which is usually in years.

Session

19

19.1

Types of Inflation

Depending upon characteristics and intensity, inflation can be of different types: b)Creeping Inflation: general rise in prices at low rate (2-4%) c)Trotting Inflation: When %age rise above 5% to almost percent. d)Galloping Inflation: usually between 10-20% e)Hyper Inflation: Above 20% and uncontrollable. Price rise at any moment.

Session

19

19.2

Measurement of Inflation

Two methods generally used to capture movement in General Price Level: b)Consumer Price Index c)Wholesale Price Index From these two indices the rate of inflation can be calculated as

( P1 − P0 )   Inflation = ×100 P0  

Session

19

19.3

Effects of Inflation

On Distribution of Income and Wealth ii.

If price of everything (assets and debt instruments) change proportionally with the price level, nobody will hurt or benefit from inflation unless those changes affect economy’s output. iii. Due to non indexation of income of the poor; due to inflation the rich get richer and poor get poorer. iv. Real Income of pensioner, wage earner etc is reduced due to inflation whereas that of profit and capital gain income grow. v. For debtor, the real value of repayment in the future will fall with inflation causing increase in his wealth

Session

19

19.3

Effects of Inflation

On Output and Growth •

•

Short Run: In underemployed economy creeping inflation is good for output and employment; when inflation is unanticipated and wages lag behind prices. Long Run: If wage lag behind inflation continuously, output will grow at faster rate as it results in higher profits. This results in high capital expenditure due to high mps.

Session

19

19.4

Inflation in AD-AS framework

Price rise is either rightward shift in AD curve of leftward shift in AS curve.

Session

19

19.5

Causes of Inflation

a) Demand Pull Inflation b) Cost Push Inflation

Session

19

19.5 • •

•

•

Causes of Inflation: Demand Pull Inflation

'too much money chasing too few goods‘ consumers are spending more, interest rates have fallen, taxes have been cut or simply because there is a greater level of consumer confidence. firms are investing more in the expectation of future economic growth. government is boosting spending on defense, health, education and so on.

Session

19

19.5

Causes of Inflation: Cost Push Inflation

Cost-push inflation happens when costs increase independently of aggregate demand. Originate from supply side. Three types: f)Wage Push Inflation g)Profit Push Inflation h)Supply Shock Inflation

Session 19