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Published by: Mithun Dey on Sep 29, 2012
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By: Ashwin Thenappan.P Sakshi Dhawan

Subsequently “ Purchasing power is falling “ .Inflation Inflation is defined as a sustained increase in the general level of prices for goods and services .

Causes • • • • • • Demand pull inflation Cost-push inflation(Supply shock -scarcity) Built-in inflation Printing more rupees Costly imports Insufficient rainfall .

Effects of Inflation • • • • • • • Real rate of return becomes low Decline in growth Unemployment Domestic currency depreciates Spending less Hyperinflation Hoarding .

Inflation Measurement • Inflation is the rate of change in prices. • The average price movement for a fixed basket of goods and services over a period of time is referred to as the Price Index. • In an economy. • Prices may be measured at the retail or wholesale level and the respective indexes are Consumer Price Index(CPI). the rate of inflation is measured by the percentage change in the Price Index. Wholesale Price Index (WPI) . and the price level is the cumulative of past inflation.

Consumer Price Index • The Consumer Price Index (CPI) is a weighted price index which measures the monthly change in the prices of goods and services. .

CPI: An Example Category Food Alcohol & Tobacco Clothing Transport Housing Leisure Services Price Index 104 110 96 108 106 102 Weighting 19 5 12 14 23 9 Price x Weight 1976 550 1152 1512 2438 918 Household Goods Other Items 95 114 10 8 100 950 912 10408 .

• Weights are attached to each category and then these weights are multiplied to the price index for each item of spending for a given year.5. Thus the rate of inflation = 8. • So if in one year the price index is 104.1 • The rate of inflation is the % change in the price index from one year to another.1 x 100. • The price index for this year is: the sum of (price x weight) / sum of the weights • So the price index for this year is 104.5 – 104. then the annual rate of inflation = (112.1) divided by 104.1 and a year later the price index has risen to 112.07% .

and they are a group of the indicators that follow growth in the economy. Wholesale price indexes (WPIs) report monthly to show the average price changes of goods sold in bulk. .Wholesale Price Index • An index that measures and tracks the changes in price of goods in the stages before the retail level.

Finalization of item Basket 3. Finalizing Classification Structure 4. Finalization of base Year 2.Steps involved in the compilation of WPI: 1. Allocation of weights at majorgroups/groups/sub-group and item level 5. Collection of Price 7. Finalization of item specification and Sources of collecting data for price 6. Calculation of Index .

Fiscal measures .Control Measures There are broadly two ways of controlling inflation in an economy: 1. Monetary measures 2.

Monetary Measures • The most important and commonly used method to control inflation is the Monetary Policy of the Central Bank. Most central banks use high interest rates as the traditional way to fight or prevent inflation. open market operations. cash reserve ratio and iii. • Monetary measures used to control inflation include: i. bank rate policy ii. .

Fiscal Measures • Fiscal measures to control inflation include taxation.). encourage imports by lowering duties on import items etc. The government can also take some protectionist measures (such as banning the export of essential items such as pulses. government expenditure and public borrowings. cereals and oils to support the domestic consumption. .

and thus inflation. an economy with no inflation has essentially stagnated • The right level of economic growth. is somewhere in the middle . an economy that is growing too fast can experience hyperinflation • At the other extreme. excessive economic growth can very detrimental • At one extreme.Inflation and Interest Rates • Contrary to popular belief.

• It's the government’s job to maintain that delicate balance • An increase in interest rates. • A decrease in interest rates aims to spur on economic growth. • While inflation is a major issue. it is not the only factor informing the government’s decisions on interest rates. For example. thus preventing a market meltdown . attempts to head off future inflation. the government might ease interest rates during a financial crisis to provide liquidity financial markets.

Inflation and Unemployment • There is an inverse relation between rate of inflation and the rate of unemployment in an economy. . • The more the entrepreneur extends the employment opportunity the more he has to pay to that particular factor of production and the more payment to factor of production the increase in the cost of producing a unit will be observed and in order to maintain the profitability of the product the entrepreneur will inflate the price of that product.

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