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Published by: gauravjindal1 on Feb 10, 2013
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What is Inflation?
Inflation is defined as an increase in the price of bunch of Goods and services that projects the Indian economy. An increase in inflation figures occurs when there is anincrease in the average level of prices in Goods and services. Inflation happens whenthere are less Goods and more buyers, this will result in increase in the price of Goods,since there is more demand and less supply of the goods.
Inflation causes increase of Interest
Inflation can be recognized as a combination of 4 factors :
The Supply of money goes up
The Supply of Goods goes down
Demand for money goes down
Demand for goods goes up
Cost-Push Inflation
 Aggregate supply is the total volume of goods and services produced by an economy at agiven price level. When there is a decrease in the aggregate supply of goods and servicesstemming from an increase in the cost of production, we have cost-push inflation. Cost- push inflation basically means that prices have been “pushed up” by increases in costs of any of the four factors of production (labor, capital, land or entrepreneurship) whencompanies are already running at full production capacity. With higher production costsand productivity maximized, companies cannot maintain profit margins by producing thesame amounts of goods and services. As a result, the increased costs are passed on toconsumers, causing a rise in the general price level (inflation).
, also called "supply shock inflation," is caused by a drop in aggregatesupply (potential output). This may be due to natural disasters, or increased prices of inputs. For example, a sudden decrease in the supply of oil, leading to increased oil prices, can cause cost-push inflation. Producers for whom oil is a part of their costs couldthen pass this on to consumers in the form of increased prices. Another example stemsfrom unexpectedly high Insured Losses, either legitimate (catastrophes) or fraudulent(which might be particularly prevalent in times of recession)
Demand-Pull Inflation
 Demand-pull inflation occurs when there is an increase in aggregate demand, categorized by the four sections of themacroeconomy: households, businesses, governments andforeign buyers. When these four sectors concurrently want to purchase more output thanthe economy can produce, they compete to purchase limited amounts of goods andservices. Buyers in essence “bid prices up”, again, causing inflation. This excessivedemand, also referred to as “too much money chasing too few goods”, usually occurs inan expanding economy.
 Demand-pull inflation is caused by increases in aggregate demand due to increased  private and government spending, etc. Demand inflation is constructive to a faster rate of economic growth since the excess demand and favourable market conditions will stimulate investment and expansion.
How are inflation and interest rates related?
With less money to spend and weaker purchasing power, people can buy fewer productscompared to before. As a consequence, demand for products declines. When supplyexceeds demand, sellers will opt to lower their prices in order to sell their products. When prices are lowered, inflation rate goes down too.So there, by imposing higher interest rates, the Bangko Sentral can control inflation. Wecan thus say that there’s an inverse relationship between interest rates and inflation.
Inflation is usually estimated by calculating theinflation rateof a price index, usually theConsumer Price Index.
The Consumer Price Index measures prices of a selection of goods and services purchased by a "typical consumer".
The inflation rate is the percentage rate of change of a price index over time.For instance, in January 2007, the U.S. Consumer Price Index was 202.416, and inJanuary 2008 it was 211.080. The formula for calculating the annual percentage rateinflation in the CPI over the course of 2007 isThe resulting inflation rate for the CPI in this one year period is 4.28%, meaning thegeneral level of prices for typical U.S. consumers rose by approximately four percent in2007.
What is a CRR rate?
Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with RBI. If RBI decides to increase the percent of this, the available amount with the banks comes

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