Theory of Inflation

It is a paradox of sorts

Meaning

Persistent and appreciable rise in prices

Diminishes the purchasing power

Keynes - expansion in the supply of money

relative to the supply of things to purchase

Too much money chases too few goods

Economy and
Inflation

Types of Inflation

Prices are determined by the intersection of

demand and supply curves

Price rises, when demand increases or

supply decreases

Two types of Inflation

Demand-Pull Inflation

Cost-Push Inflation

Demand-Pull Inflation

Excess of demand for

goods over their supply

Assumption - there is
full employment in the
economy, hence AS
cannot increase much

Aggregate Supply (AS)

remains contact at the
level of full employment

Demand-Pull Inflation

Causes
Black
Money

Disposable
Income

Public
Expenditur
e

Deman
d Pull
Inflatio
n

Population
Size

Money
Supply

Cost-Push Inflation

Rise in price is due to

the rise in the cost of
production

Demand stays
unchanged, supply
factor is critical.

Has a domino effect,

i.e., it ripples out to
other industries (For
example - Brent Oil)

Cost-Push Inflation

Causes
Price Wage
Spiral

Administere
d Prices

Availability
of Basic
Inputs

Profit
Margin

Cost
Push
Inflatio
n

Taxes

Causes of Inflation
Demand
Factors

Supply
Factors

Monetar
y and
Fiscal
Factors

Inflatio
n

Demand Factors

Growth of
population

Rise in employment
and income

Increasing pace of
urbanization

Supply Factors

Irregular agricultural supply

Hoarding of essential goods

Rise in administered prices

Inadequate growth of industrial production

Agricultural price policy

Rising prices of imports

Monetary and Fiscal

Factors

Rising levels of government expenditure leads to increase in the money supply

Deficit Financing

Quantitative Easing (Add-on) used

recently by the Fed in the US, in use by the
Japan, was used in the form stimulas by
the Union Government during the financial
crisis.

Benefits of Inflation

Raises capital formation

Beneficial for producers and traders

Businessmen and rich classes are gainers

Debtors are gainers

Farmers are gainers

Dangers of Inflation

Rise in inequalities of income and wealth

Disrupts execution of projects

Rise in black money

Loss of tax revenue

Creditors, wage salary, consumers and small

investors face losses

High cost economy

Monetary Measures
Quantitati
ve

Qualitativ
e

Moral
Suasion

Taming
Inflation

Monetary Measures
1. Qualitative Instruments

Raise Bank Rate

Open Market Operations

Variable Reserve Ratio

Raise Cash Reserve Ratio

Raise Statutory Liquidity Ratio

2. Quantitative Instrument

Raise Marginal Requirement

3. Moral Suasion

Fiscal Measures

Determined through the fiscal policy of the

Government.

Instruments

Revenue Policy - determining the

taxation system.

Expenditure Policy - maintaing the

public expenditure system.

Other Measures

Control of prices

Wage freeze

Dividend freeze

Population control measures

Increase in supply of goods

Increased agricultural production

Increased industrial consumer goods production

Public Distribution of Essential Goods

Integration of Prices and Income

Measuring Inflation
Inflation

Wholesale
Price Index
(WPI)

Consumer
Price Index
(CPI)

Measuring Inflation
Wholesal
e Price
Index

Price of a
representative
basket of
wholesale goods
Focuses on the
price of goods
traded between
corporations,
rather than goods
bought by
consumers

Consum
er Price
Index

Price change from

the perspective of
the retail buyer

Measures changes
overtime in the
level of retail
prices of selected
goods and
services

Pop-up Quiz

What method is currently used to

measure inflation in India?

Price Control
Price
Floor

Price
Ceiling

Restriction on the
minimum price at
which the good or
service can be
sold

Restriction on the
highest price at
which the good or
service can be
sold

Prevent price
gouging, common
in India, to tame
inflation

Prevents inflation
by ensuring
producers have a
minimum income

Thats it.
Any questions?

Group Members

Mohit Jindal 446

Akansha Makkar 383

Aniket Agrawal 27

Khushboo Gupta - 392