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Inflation

Inflation

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Published by abdulhadiqureshi
Information about Inflation types of inflation etc
Information about Inflation types of inflation etc

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Published by: abdulhadiqureshi on Dec 13, 2008
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12/23/2012

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Q. #:
What is inflation? Also mention its relative causes, remedies and kinds. 
INFLATION:
Inflation is a process in which the price is rising at a rapid rate and the moneyis losing its value. In the words of Gardner Ackley, “Inflation may be defined as apersistent and appreciable rise in general level of average of prices.” It may heredenote that rising general level of price doesn’t mean that all prices are necessarilyrising. Even during inflation, the prices of some goods may remain relatively constantand a few others actually falling. Inflation also does not mean that prices of goodsrise evenly or proportionately. Inflation is an upward movement in the general(average) level of prices. In Pakistan, the general price level is persistently risingsince Partition of the Subcontinent. Prices remained volatile during the decade of 1990’s ranging form 5.7% to 13% mainly because of declining economic growth,expansionary policies, output set backs, higher taxes and a depreciation of Pakistanirupee. The inflation rate started declining form 1998 on ward due to improved supplyposition of goods, strict budgetary measures. The inflation rate was 5.7% in 1998-99.It was brought down to 3.6% in 1992-2000 and further to 3.1% in 2002-03. Theinflation rate based on the CPI (Consumer Price Index) has averaged 4.6% during2003-04. The slight rise in prices was the year 2004-05 mainly due to rise in theprice of wheat and an increase in the international oil price.
CAUSES OF INFLATION:
The causes of inflation are generally grouped under two main heads (a) DemandPull Inflation (b) Cost Push Inflation.
A.
 
Demand Pull Inflation:
Demand pull inflation occurs when aggregate demand for goods exceedsaggregate supply of goods at current prices, thus leading to an increase in the pricelevel. The factors of which bring about increase in aggregate demand for goods or rise in the general level of prices are grouped under two separate heads; (i) Factorsoperating on demand side (ii) Factors operating on the supply side.
(a)
 
Factors operating on the demand side
: These are the factors which bringcontinuous rise in the general price level.
(1)
 
Increase in money supply
: An increase in money supply leads to an increase inmoney income. The increase in money income raises the aggregate demand for goods and services in the country. The supply of money increases when the govt.resorts to deficit financing or the commercial banks expand credit. When too muchmoney chases too few goods, the result is an increase in general price level.
(2)
 
Increase in Government expenditure
: If there is increase in govt. expendituredue to adoption of development and welfare activities of the country has to flight awar, it causes as increase in govt. expenditure which leads to increase in aggregatedemand for goods and services and hence the price level goes up.
1
 
(3)
 
Increase in private expenditure:
A continuous increase in consumption andinvestment expenditure in the private sector raises the demand for goods andservices and leads to inflationary rise in prices.
(4)
 
Increase in population:
The rapid rising population exerts pressure on thedemand for goods and services. If the supply of goods and services fail to matchwith the demand, the general price level moves upward.
(5)
 
Black money:
The money generated through smuggling, tax evasion etc. raisesthe demand for luxury and other goods. Hence black money is also one of thecauses in raising the aggregate demand for goods and a rise in general price level.
(b)
 
Factors causing decrease in supply of goods:
If the increase in aggregatedemand for goods and services is matched by an increase in the supply of goods, itwill not cause inflationary situation. When the aggregate supply of goods is at aslower pace than the growth in aggregate demand, it then causes inflationary rise inprices. The following factors are identified for relatively slower growth in the supply of goods.
(i)
 
Lagging agricultural & industrial production:
The increase in population,incomes, employment and urbanization exert pressure on the demand for goods andservices. However, the agricultural and industrial production grows at a slower pace,due to shortage of essential inputs like fertilizers, water, cement, iron etc. Whenaggregate demand for goods and services exceeds the aggregate supply of it, itcauses a rise in the prices of agricultural and industrial goods.
(ii) Inadequate infrastructure facilities:
If, in a country there is shortage of power,transport and communication facilities are slow and inefficient, it results in theslowing down of overall production of goods. When the supply of goods falls short of demand, the prices go up in the country.
(iii) Long gestation period:
If the time lag between investment and the productionof goods is long, the shortage of goods will arise. This will also contribute toinflationary pressure in the economy.
B. Cost Push Inflation:
Cost push inflation occurs when there is an increase in the cost of productionof goods and is not associated with excess demand. The main causes of cost pushinflation are:
(1) Increase in money wage rate:
The wage push inflation occurs when stronglabour unions manage to press for wage increases in excess of labour productivity.Unit cost of production is thereby raised. The rise in cost of production exertspressure on sellers to increase prices of goods so as to get profit margin.
(2) Profit push inflation:
If the producers of certain commodities have monopoly or near monopoly power in the market, they fix up higher profit margins arbitrarilywithout any increase in other elements of cost. When a few powerful firms increasethe profit margins, the smaller firms also tend to mark up their profit margins. Thehigher profit margins, thus, inflate the price level.
2
 
(3) Material push inflation:
If there is increase in the prices of some basic materialssuch as gas, steel, chemicals, oil etc which are used directly or indirectly in almost allindustries, it causes an increase in the cost of production and hence in the generalprice level.
(4) Higher taxes:
If the government levies new taxes and raises the rates of oldtaxes the producers generally shift the burden of taxes on to the consumers. Theincreases in the selling prices of the commodities push up the inflationary trend inthe economy.
(5) Import prices:
If prices of imported goods increase, it also results in thecontribution of inflation.
KINDS OF INFLATION:
Inflation is of different types. It is generally classified on the following basis.
On the Basis of Rate of Inflation:(i) Creeping Inflation:
It is a situation in which the rise in general price level is at avery slow rate over a period of time. Under creeping inflation, the price level raisesupto a rate of 2% per annum. A mild inflation is generally considered a necessarycondition of economic growth.
(ii) Walking Inflation:
Walking inflation is a marked increase in the rate of inflationas compared to creeping inflation. The price rise is around 5% annually.
(iii) Running Inflation:
Under running inflation, the price increases is about 8% to10% per annum.
(iv) Galloping or Hyper Inflation:
Galloping inflation is a full inflation. Keynes calls itas the final stage of inflation. It is a stage of inflation which starts after the level of fullemployment is reached. Here price level rises very rapidly within a short period.
On the Basis of Degree of Control:(i) Open Inflation:
It is a stage when the rise in price level gets out of control. MiltonFriedman describes it as “inflationary process in which prices are permitted to risewithout being suppressed by government price control or similar measures.
(ii) Suppressed Inflation:
Under this type of inflation, the government makes effortsto check and control the rise in price level through price and rationing. When pricelevel is suppressed by the above short term measures, it results in many evils suchblack marketing, hoarding, corruption & profiteering.
Inflation on the Basis of Causes:(i) Demand Pull Inflation:
Inflation caused by increase in aggregate demand, notmatched by aggregate supply of goods, resulting in rise of general price level iscalled demand pull inflation. Demand pull inflation to be simpler, occurs when thedemand for goods and services in the country is more than their supply. The effective
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