Inflation

Inflation is a persistent rise in the average price level of goods and services over time in an economy which can also be translated as the decline of purchasing power overtime.

It is calculated as the percentage rate of change in the average price level of a selection of products and services that are bought by businesses or consumed by households.

A rise in demand, a fall in supply, changes in production costs, or adjustments in governmental policy are just a few of the variables that can lead to inflation.

High inflation can harm an economy by reducing purchasing power, eroding consumer confidence, and deterring investment. On the other hand, a low rate of inflation can point to a strong and stable economy.

Inflation: Types

1. Demand-pull inflation: Demand-pull When the general demand for goods and services grows more quickly than the economy’s capacity to produce them, inflation results. This happens when the quantity of money and credit increases. This drives up demand and raises prices.
2. Cost-push inflation: This type of inflation occurs when the cost of production increases due to factors such as rising wages, higher raw material costs, or taxes. This increase in production costs leads to an increase in prices, as businesses pass on the additional costs to consumers.
3. Built-in inflation: As cost-push inflation and demand-pull inflation emerge, employees may start seeking higher pay from their employers. To avoid the risk of a labor shortage, employers need to offer competitive wages. In some cases, companies may resort to built-in inflation, which involves raising employee salaries while increasing prices to maintain profit margins.

Inflation: Causes

1. Increase in Demand: Growing Population and Purchasing Power  due to increase in Per Capita Income, triggers inflation when productivity is not at the same level of demand.
2.  Exports: The total output of an economy must meet both domestic and international demand. So in a situation where the total output does not meet the total demand, exports lead to domestic economic inflation if it is unable to satisfy the demands of its own citizen.
3. Hoarding:Stockpiling goods and keeping them off the market are known as hoarding. Consequently, the economy is experiences an excess of demand that has been artificially manufactured. Inflation is a result of this.
4. Global Factors: Some items need to import raw materials or other production components from global markets; if their prices rise for any reason, this contributes to domestic market inflation. Also due to the global price fluctuations on important commodities like Crude Oil causes inflation in a country.
5. Monetary Policy: probable that there will be shortages of specific production ingredients at various times. As a result, prices are rising and inflation is occurring since the supply is less than the demand.
6. Imposition of Indirect Taxes: Indirect taxes raise the overall cost for producers and/or sellers; as a result, they raise the price of the good to have a minimal effect on producers’ profit margins.

Inflation: Measurement

There are two indices that are used to measure inflation in India — the consumer price index (CPI) and the wholesale price index (WPI).

• WPI, as its name suggests, measures wholesale prices, and the Reserve Bank of India utilised it until 2014 to determine monetary policy.
  • The cost of a typical basket of wholesale goods is what is known as the wholesale pricing index (WPI).
  • It illustrates the overall expenditures after taking a basket of 697 items into account. Manufactured Products (65% of total weight), Primary Articles (food, etc.) (20.1%), and Fuel and Power (5% of total weight) make up the WPI basket (14.9 percent).
  • The Ministry of Commerce and Industry calculates the WPI.
• CPI is a gauge of changes in retail prices based on 260 commodities, some of which include services.
  • The Ministry of Statistics and Programme Implementation regularly gathers pricing for representative goods and services (usually once per month) and keeps track of any changes.
  • A base year is used to compare rate measures. This year can be viewed as the ‘first’ year in the specified time period.
  • Prices in the base year are usually set to be 100 in order to simplify calculations.

Inflation: Impact

Positive

1.   Increased economic growth: Increasing prices might encourage consumers to spend and invest which will boost the economy and create jobs.
2. Higher Profits: Typically, inflation is advantageous to product manufacturers. They make more money because they can sell their goods for more money.
3. Better Investment Returns: Entrepreneurs and investors are given more incentives to invest in profitable ventures during periods of inflation. They consequently get better returns.
4. Boost in Production: When producers have the proper funding, they start producing more goods and services. So, as a result of inflation, more goods and services are produced.
5. Rise in wages: Because workers need more money to keep up with rising costs, inflation might result in higher pay.
6. Reduces the burden of debt: Inflation can reduce the real burden of debt because the amount of money owed remains constant while the value of money decreases over time. This can be particularly helpful for borrowers who are struggling to repay their debts.

Negative

1. Reduced purchasing power: Inflation can reduce the purchasing power of consumers as prices rise, which can lead to a decrease in the standard of living.
2. Increased uncertainty: Inflation can create uncertainty in the economy, making it difficult for businesses and individuals to plan for the future.inflation reduces the value of money over time, meaning that savings and investments may be worth less in the future than they are today, leading to further uncertainty and financial instability.
3. Redistribution of income and wealth: Inflation can lead to a redistribution of income and wealth, as those who own assets that appreciate in value during inflation (such as real estate) benefit, while those who hold cash or have fixed incomes may suffer.
4. Increased interest rates: Inflation can lead to higher interest rates as the central bank tries to control inflation by raising borrowing costs. This can make it more expensive for businesses and individuals to borrow money.
5. Reduced international competitiveness: Inflation can make a country’s goods and services more expensive relative to other countries, reducing its international competitiveness.

Inflation: Control Measures

• Monetary policy: The central bank can use monetary policy to control inflation by adjusting interest rates or the money supply in the economy. Increasing interest rates can reduce demand and lower inflation, while decreasing interest rates can stimulate demand and increase inflation.
• Fiscal policy: The government can use fiscal policy, such as reducing overall government spending and transfer payments by taking the appropriate action and Raising tax rates will make people spend less overall, which will reduce demand and reduce the amount of money available in the economy.
• Other Measures:
  • Supply-side policies: Supply-side policies, such as reducing production costs or increasing productivity, can increase the supply of goods and services in the economy and lower prices. For example, to increase the production of essential consumer goods like food, clothing, vegetable oil, sugar, etc. And raw material essential for production and manufacturing.
  • Price controls: The government can implement price controls on certain goods and services to prevent prices from rising too quickly. However, price controls can have unintended consequences, such as shortages or black markets.
  • Wage controls: The government can also implement wage controls to prevent wages from rising too quickly, which can lead to higher production costs and higher prices.