Managerial Economics

Inflation
G. Ackley defined inflation as ‘a persistent and appreciable rise in the general level or average of
prices’. Inflation is the increase in the prices of goods and services over time. 

Inflation leads to a decline in the value of money. “Inflation means that your money won’t buy as
much today as you could yesterday.”

Effects of Inflation:

The following points highlight the major effects of inflation.

1. Effects on Distribution of Income and Wealth:

The impact of inflation is felt unevenly by the different groups of individuals within the national
economy—some groups of people gain by making big fortune and some others lose.

(a) Creditors and debtors:

During inflation creditors lose because they receive in effect less in goods and services than if
they had received the repayments during a period of low prices. Debtors, on other hand, as a
group gain during inflation, since they repay their debts in currency that has lost its value
(i.e., the same currency unit will now buy less goods and services).

(b) Producers and workers:

Producers gain because they get higher prices and thus more profits from the sale of their
products. As the rise in prices is usually higher than the increase in costs, producers can earn
more during inflation. But, workers lose as they find a fall in their real wages as their money
wages do not usually raise proportionately with the increase in prices. They, as a class,
however, gain because they get more employment during inflation.

(c) Fixed income-earners:

Fixed income-earners like the salaried people, rent-earners, landlords, pensioners, etc.,
suffer greatly because inflation reduces the value of their earnings.

(d) Investors:
The investors in equity shares gain as they get dividends at higher rates because of larger
corporate profits and as they find the value of their shareholdings appreciated. But the
bondholders lose as they get a fixed interest the real value of which has already fallen.

(e) Traders, speculators, businesspeople and black-marketers:

They gain because they make more profits from the persistent rise in prices.
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(f) Farmers:
Farmers also gain because the rise in the prices of agricultural products is usually higher than
the increase in the prices of other goods.

Thus, inflation brings a shift in the pattern of distribution of income and wealth in the country,
usually making the rich richer and the poor poorer. Thus during inflation there is more and more
inequality in the distribution of income.

2. Effects on Production:

When prices start rising production is encouraged. Producers earn wind-fall profits in the future.
They invest more in anticipation of higher profits in the future. This tends to increase
employment, production and income. But this is only possible up to the full employment level.

Further increase in investment beyond this level will lead to severe inflationary pressures within
the economy because prices rise more than production as the resources are fully employed. So
inflation adversely affects production after the level of full employment.  Inflation has a favorable
effect on production when there are under- utilized or under-employed resources in existence in
an economy. Rising prices breed optimistic expectations within the business community, in view
of increasing profit margins, because the price level moves up at a faster rate than the cost of
production.

3. Effects on Income and Employment:

Inflation tends to increase the aggregate money income (i.e., National Income) of the community
as a whole on account of larger spending and greater production. Similarly, the volume of
employment increases under the impact of increased production. But the real income of the
people fails to increase proportionately due to a fall in the purchasing power of money.

It is argued that countries with higher inflation rates tend to have lower investment and
therefore lower economic growth. Therefore, if there are poor levels of investment this could
lead to higher unemployment in the long term. Countries with low inflation rates, such as
Germany have enabled a long period of economic stability which helps to attain a long term low
unemployment rate. Low inflation in a country like Germany also helps them to become more
competitive within the Euro zone, which also helps create employment and reduce
unemployment.

4. Effects on Business and Trade:

The aggregate volume of internal trade tends to increase during inflation due to higher incomes,
greater production and larger spending. But the export trade is likely to suffer on account of a
rise in the prices of domestic goods. However, the business firms expand their businesses to
make larger profits.
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During most inflation since costs do not rise as fast as prices profits soar. But wages do not
increase proportionate with prices, causing hardships to workers and making more and more
inequality. As the old saying goes, during inflation prices move in escalator and wages in stairs.

5. Effects on the Government Finance:

During inflation, the government revenue increases as it gets more revenue from income tax,
sales tax, excise duties, etc. Similarly, public expenditure increases as the government is required
to spend more and more for administrative and other purposes. But the rising prices reduce the
real burden of public debt because a fix sum has to be paid in installment per period.

6. Effects on Growth:

A mild inflation promotes economic growth, but a runaway inflation obstructs economic growth
as it raises cost of development projects. Although a mild dose of inflation is inevitable and
desirable in a developing economy, a high rate of inflation tends to lower the growth rate by
slowing down the rate of capital formation and creating uncertainty.

Desirability of Inflation:

A moderate rate of inflation is considered to be desirable for the economy. Today, most economists
favor a low and steady rate of inflation. Low (as opposed to zero or negative) inflation reduces the
severity of economic recessions by enabling the labor market to adjust more quickly in a downturn,
and reduces the risk that a liquidity trap prevents monetary policy from stabilizing the economy. The
Federal Reserve has not established a formal inflation target, but policymakers generally believe that
an acceptable inflation rate is around 2 percent or a bit below.

Policy measures to control Inflation:

Inflation is considered to be a complex situation for an economy. If inflation goes beyond a moderate
rate, it can create disastrous situations for an economy; therefore is should be under control.

It is not easy to control inflation by using a particular measure or instrument. The main aim of every
measure is to reduce the inflow of cash in the economy or reduce the liquidity in the market.

Inflation can be reduced by policies that slow down the growth of Aggregate Demand (AD) and/or
boost the rate of growth of Aggregate Supply (AS)

Some of the important measures to control inflation are as follows:

1. Monetary Measures:

Monetary measures aim at reducing money incomes.

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(a) Rise in Bank Rate:

The bank rate is the rate at which the commercial bank gets a rediscount on loans and
advances by the central bank. The increase in the bank rate results in the rise of rate of
interest on loans for the public. This leads to the reduction in total spending of individuals.

(b) Direct Control on Credit Creation:

Constitutes the major part of monetary policy.

The central bank directly reduces the credit control capacity of commercial banks by using the
following methods:

(i) Performing Open Market Operations (OMO):

Refers to one of the important method used by the central bank to reduce the credit creation
capacity of commercial banks. The central bank issues government securities to commercial
banks and certain private businesses.

In this way, the cash with commercial banks would be spent on purchasing government
securities. As a result, commercial bank would reduce credit supply for the general public.

(ii) Changing Reserve Ratios:

Involves increase or decrease in reserve ratios by the central bank to reduce the credit
creation capacity of commercial banks. For example, when the central bank needs to reduce
the credit creation capacity of commercial banks, it increases Cash Reserve Ratio (CRR). As a
result, commercial banks need to keep a large amount of cash as reserve from their total
deposits with the central bank. This would further reduce the lending capacity of commercial
banks. Consequently, the investment by individuals in an economy would also reduce.

2. Fiscal Measures:

Apart from monetary policy, the government also uses fiscal measures to control inflation. The
two main components of fiscal policy are government revenue and government expenditure. In
fiscal policy, the government controls inflation either by reducing private spending or by
decreasing government expenditure, or by using both.

It reduces private spending by increasing taxes on private businesses. When private spending is
more, the government reduces its expenditure to control inflation. However, in present scenario,
reducing government expenditure is not possible because there may be certain on-going projects
for social welfare that cannot be postponed.

Besides this, the government expenditures are essential for other areas, such as defense, health,
education, and law and order. In such a case, reducing private spending is more preferable rather
than decreasing government expenditure. When the government reduces private spending by
increasing taxes, individuals decrease their total expenditure.
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For example, if direct taxes on profits increase, the total disposable income would reduce. As a
result, the total spending of individuals decreases, which, in turn, reduces money supply in the
market. Therefore, at the time of inflation, the government reduces its expenditure and increases
taxes for dropping private spending.

3. Price Control:
Another method for ceasing inflation is preventing any further rise in the prices of goods and
services. In this method, inflation is suppressed by price control, but cannot be controlled for the
long term. In such a case, the basic inflationary pressure in the economy is not exhibited in the
form of rise in prices for a short time. Such inflation is termed as suppressed inflation.

4. Other Policies to Reduce Inflation:

(a) Wage Control:
If inflation is caused by wage inflation (e.g. powerful unions bargaining for higher real wages),
then limiting wage growth can help to moderate inflation. Lower wage growth helps to
reduce cost-push inflation and helps to moderate demand-pull inflation.

(b) Monetarism

Monetarism seeks to control inflation through controlling the money supply. Monetarists

believe there is a strong link between the money supply and inflation. If you can control the
growth of the money supply, then you should be able to bring inflation under control.
Monetarists would stress policies such as:
 Higher interest rates (tightening monetary policy)
 Reducing budget deficit (deflationary fiscal policy)
 Control of money being created by government

However, in practice, the link between money supply and inflation is less strong.

(C) Supply Side Policies

Often inflation is caused by persistent un-competitiveness and rising costs. Supply-side

policies may enable the economy to become more competitive and help to moderate
inflationary pressures. For example, more flexible labour markets may help reduce
inflationary pressure. However, supply side policies can take a long time, and cannot deal
with inflation caused by rising demand.

(d) Ways to Reduce Hyperinflation – change currency

In a period of hyperinflation, conventional policies may be unsuitable. Expectations of future
inflation may be hard to change.  When people have lost confidence in a currency, it may be
necessary to introduce a new currency or use another like the dollar (e.g. Zimbabwe
hyperinflation).
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Conclusion:

To control inflation, the government should adopt all measures simultaneously. Inflation is like a
hydra- headed monster which should be fought by using all the weapons at the command of the
government.
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Globalization
International business refers to the trade of goods, services, technology, capital and/or knowledge
across national borders and at a global level. The volume of trade has grown over time, it has grown
very rapidly during the post World War II period.
The International business environment has undergone a tremendous change since 1990. The word
that summarizes the changing global business environment is “Globalization”. Globalization refers to
free flow of goods & services, capital & labor, technology and finance between the nations.
Globalization is a process of integration of the world into one market by removal of all the political,
geographical trade and business barriers among nations.

Factors behind Globalization:

 Containerisation
The costs of ocean shipping have come down, due to containerisation, bulk shipping, and other
efficiencies. This reduces the cost of transporting goods. Containerisation supported the post-war
boom in international trade, and was a major element in globalization.

 Technological change
Rapid and sustained technological change has reduced the cost of transmitting and
communicating information– a key factor behind trade in knowledge products using web
technology

 Reduction in Cross-trade Barriers:

Governments are removing international business restrictions. Gradual relief in the cross-border
trade restrictions by most governments induces free trade, which, in turn, increases the growth
rate of an economy. The World Trade Organization (WTO) is committed to lowering barriers to
trade. For example, since major reforms to liberalize market since the 1978 and trade, China
experienced some of the highest GDP growth (around 10%) in the world for decades where
millions were lifted out of poverty.

 Increase in Consumer Demand:

Over the years, with increase in the level of income and standard of living, the demand of
consumers for various products has also increased. Apart from this, nowadays, consumers are
well aware about products and services available in other countries, which drive many
organizations to work in association with foreign players for catering to the needs of the
domestic market.

 Technologies: 
The stage of technology in a particular field gives rise to import or export of products or services
from or to the country. For example: Today, India is exporting computers/ software related
services to advanced counties like UK, USA, France, Australia, NZ etc.
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Consequences of Globalization:

As a result of globalization, the economic growth of both developing and developed countries is
impacted positively and negatively. Here are some of the positive and negative effects of
globalization

 Gives access to a larger market– through globalization countries and companies have access to

a bigger consumer base. Instead of only selling products in their country a business can expand
to other regions boosting sales and in the process making more money.
 Provides cheaper goods for consumers– because of globalization a lot of companies are moving
to areas where their cost of production is low they, in turn, offer cheaper products because they
are not expensive to make hence lower prices for consumers.
 Leads to better economies– With many multination’s heading to Africa to tap the consumer
base in this part of the world more jobs are being created helping people in these countries get
better wages and improve their stands of living. These investments by these multinationals or
foreign countries also help strengthen the economies of these countries with the foreign
exchange they bring in. With an increased number of investors looking for investments
opportunities around the globe, country economies will benefit wherever they invest. Through
globalization economies of different countries are becoming more connected to one another
since they depend on each other for trade.
 Free movement of labor-Globalization has led to increase in the movement of people. For
example, about 30,000 Indians are working in Silicon Valley in U.S.A. Increased labor migration
gives advantages to both workers and recipient countries. 

Despite many well-proven benefits, globalization’s been severely criticized by many for the following
reasons:

 Globalization is working mostly in favour of rich countries. They continue to dominate

the world politics and economy at the expense of developing/poor countries, whose role is
mostly to provide the richer countries with cheap labors and cheap raw materials.
 There are no guarantees that the wealth created from foreign investment will benefit
local community (even in the form of business income tax) as often most of the profits are
sent back to developed countries where investors are based.
 Giant multinational companies have been driving local businesses to the ground cause
they simply can’t compete.
 The competition to attract foreign investment is so severe, countries sometimes make
great compromises just to ensure steady flow of foreign capital. Putting the environment,
safety of working people as well as their earning potential at high risk. At the same time,
there not enough strict international laws to regulate these aspects.
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Managerial Implications of Globalization:

Globalization of the world economy has serious implications for managerial decision making. Some
major areas of managerial problems that business managers are facing & are likely to face in future
too are pointed out here.

1. Facing International Competition:

The most challenging task that managers are currently facing is International Competition. The
most important factor that figures in competing with rival firms in both domestic & foreign
markets is price competition. Globalization has lead to increased market competition, hence
leading to fluctuation in prices.
For example, Companies from developed countries like the USA have been forced to reduce
their products prices, because countries such as China offer the same products at cheaper
prices. For the US companies reducing prices will have a negative effect on their profits which in
turn may lead to actions like laying off workers.

2. Formulation of New and Effective Business Strategy:

Formulation of a new business strategy in the fast changing world becomes one of the prime task
of the business managers. Strategy formulation involves various parameters which vary from
country to country and from time to time and go beyond the control of managers.

The parameters include;

a) Political environment
b) Economic policies of the country, particularly policies related to foreign companies
c) Social & cultural environment of the country

For E.g. Food items of Beef would not be accepted by Hindu community in India; McDonald has
done better business by introducing many vegetarian preparations in its Indian retail chains
becoz majority of population is vegetarian.

3. Efficient Labour Management:

Globalization has made labour laws flexible. One of the methods of facing competition is keeping
cost of production at competitive level, if not lower. Where labour accounts for 30-40 percent of
the total cost, Keeping cost low means keeping labour cost low. Most developed countries facing
labour shortage are outsourcing labour from developing countries.

For e.g. High salaries offered by the MNCs to MBAs of IIMs of India have raised the managers
salary for the Indian firms. Indian firms have to increase the salary of managers just to retain
their managerial manpower. Not only retaining manpower, maintain and increasing labour
efficiency to International Level is an equally important managerial task.
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4. Managing Technology transfers:

An important effect of Globalization is transfer of technology from one country to another. Most
technology transfers are taking place from the countries making investment in foreign countries.
Managerial problems that are related to technology transfer include

a) Choice of technology
b) Acquiring chosen technology
c) Determining terms of technology transfer
d) Creating conditions for social and political acceptability of the technology

Specifically the basic problem is choosing and adopting a technology which is cost effective and
suitable for quality of labour available in the country of investment.

5. Understanding of the basics of international trade:

For the firms involves in foreign trade, it is essential to understand the basic of international
trade and related issues. Some of the important areas in which business managers must have a
clear understanding and operational ability are following:

o Basic of International trade

o Foreign trade policy of different countries, restrictions & control measures
o Customs policy of different countries
o Economic strengths of the country and future prospects of the economy
o Foreign exchange market & foreign exchange rate policy of the country
o Country’s cooperation with the international organizations like IMF, WTO, World
Bank etc. and following the rules & regulations set by them.

Conclusion:

Globalization has impacted nearly every aspect of modern life and continues to be a growing force in
the global economy. While there are a few drawbacks to globalization, most economists agree that
it's a force that's both unstoppable and net beneficial to the world economy. There have always been
periods of protectionism and nationalism in the past, but globalization continues to be the most
widely accepted solution to ensuring consistent economic growth around the world.