Inflation


 
 
Concept Explanation
 

Inflation

Inflation :

It is the rate at which the general level of prices for goods and services is rising and subsequently purchasing power is falling. Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every rupee you own buys a smaller percentage of a good or service.

The value of a rupee does not stay constant when there is inflation. The value of a rupee is observed in terms of purchasing power, which is the real, tangible goods that money can buy. When inflation goes up., there is a decline in the purchasing power of money. For example, if the inflation rate is 2% annually, then theoretically a Re 1 pack of gum will cost Rs. 1.02 in a year. After inflation, your money can't buy the same amount of goods it could beforehand.

Stages Of Inflation

  • Creeping inflation (0 - 3%).
  • Trotting inflation (Walking And Running Inflation) (3% - 10%).
  • Galloping inflation(10% - 20%).
  • Hyper inflation (20% and above).
  • Note - Percentage values are only approximate. Data may vary.
  • Causes Of Inflation

  • Demand Pull inflation (Wage Pull Inflation) - This is the typical situation in which demand is more and supply is less (commonly referred to as the "demand - pull" occurrence, or "excess demand inflation"). When wage inflation occurs, the prices for the product or service increase, thus leading into the situation known as demand - pull inflation. An example of this would be the dramatic changes in the economy during war.
  • Cost - Push Inflation - When an increase of price occurs in regard to the product or maintenance of a service or product, the expected increase in price is the resultant effect. For an example, if a car manufacturer paid more for a vital part of an engine, the labor cost would decrease to counter the new price.
  • Factors responsible for inflation:

    On the Basis of Demand

    1.Increase in nominal money supply

    2. Increase in disposable income

    3. Expansion of credit

    4. Deficit financing policy

    5.Black money spending

    6. Repayment of public debts

    7. Expansion of the private sector On the Basis of Supply

    1. Shortage of factors of production or inputs

    2. Natural calamities

    3. Artificial scarcities

    4.Increase in exports (excess exports)

    5. Neglecting the production of consumer goods

    Effects of Inflation on Economy :

    1. When the balance between supply and demand goes out of control, consumers could change their buying habits, forcing manufacturers to cut down production.

    2. Inflation can create major problems in the economy. Price increase can worsen the poverty,affecting low income household.

    3. Inflation creates economic uncertainty and is a dampener to the investment climate, slowing growth and finally reducing savings and thereby consumption.

    4. The producers would not be able to control the cost of raw material and labour, and hence, the price of the final product. This  could result in less profit or in some extreme case no profit, forcing  them out of business.

    5. Manufacturers would not have an incentive to invest in new equipment and new technology.

    6. Uncertainty would force people to withdraw money from the bank and convert long lasting value like gold, artifacts, etc

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