INFLATION

DEINITIONS
• A situation of substantial and rapid general increase in the level of prices
and consequent deterioration in the value of money over a period of time.

“ Inflation is the process of price increase.”

-Prof. Rowan

“ A sustained rise in prices”

-Harry Johnson

“ A state in which the value of money is falling i.e. prices are rising”
-Crowther

“Inflation occurs when the general level of prices and costs are rising”
- Prof. Samuelson

“ A persistent and appreciable rise in the general level of prices.”

- Edward Shapiro.
• TWO DISTINCT VIEWS ON CONCEPT OF
INFLATION
– Inflation As A Pure Monetary Phenomenon
– Post Full Employment Inflation

• INFLATION AS A PURE MONETARY PHENOMENON

– When money supply exceeds the normal absorbing capacity of
the economy, it leads to persistently rising prices.

– Overexpansion of money supply and too much money chasing

too few goods.

“Inflation occurs when the volume of money activity bidding for

goods and services increases faster than the available supply of
goods, when the growth of national income in money units is
greater than its growth in physical units.”
-Goldenweiser
P = MV / T
Assuming V and T to be constant , P rises directly in
proportion to the increase in money supply (M).

CRITICISM
The theory failed to explain the phenomenon of hyper-
inflation, where the rise in the prices may cause an increase
in the money supply which in turn , may cause a further
rise in prices.

Money and prices chase each other, therefore not easy o to

determine which is the cause and which is the effect.

Government resorts to usual fiscal and monetary techniques

to counter the evils of depression, and the result is both an
increase in money supply and a rise in prices.
• INFLATION AS A PHENOMENON OF FULL-EMPLOYMENT.
- KEYNES & PIGOU

• Rising prices in all situations cannot be termed as Inflation.

• Inflation occurs in a situation where there is an increase in demand

expressed through more spending but no corresponding increase in
production either du to bottlenecks operating in the economy or because
the economy has already reached the full employment level.

• Therefore, rising prices in all situations cannot be termed as inflation.

• “ In a condition of underemployment, when an increase in money supply

and rising prices are accompanied by the expansion of output and
employment, but when there are bottlenecks in the economy, an increase
in money supply may cause cost and prices to rise more than the
expansion of output and employment. ONCE FULL EMPLOYMENT LEVEL IS
REACHED, the entire increase in money supply is reflected simply by the
rising prices”.
• - KEYNES
• KEYNES mentions
1. Reflation
2. Inflation
3. Disinflation
4. Deflation

1. REFLATION
1. Situation of rising prices.
2. With rising prices, employment, output and income also increase till the
economy reaches the full employment ceiling

2. INFLATION
1. Inflation is a long- term operating dynamic process.
2. Inflation is a persistently rising price level.
3. Inflationary price is persistent and should be distinguished from a price rise
which may occur temporarily, due to short-term scarcity or during a cyclical
upswing.
4. Inflation is fostered by the interaction of a multitude of economic factors.
5. Inflation, in a real sense, is a post-full employment phenomenon.
6. By and larger Inflation is a monetary phenomenon., usually characterised by
overflow of money and credit.
3. DISINFLATION
– When prices are falling due to anti-inflationary measures
adopted by the authorities, with no corresponding decline in
the existing level of employment, output and income, the
result is Disinflation.
– Takes place when deliberate attempts are made to curtail
expenditure of all sorts to lower prices and money incomes for
the benefit of the community.

4. DEFLATION
– Occurs when the total expenditure of the community is not
equal to the existing prices. Consequently, the value of money
goes up and prices fall.
– Each and every fall in price cannot be called deflation.
– The process of reversing inflation without either creating
unemployment or reducing output is called Disinflation and
not Deflation.
– DEFLATION IS AN UNDEREMPLOYMENT PHENOMENON.
 TYPES OF INFLATION
ACCORDING TO ACCORDING TO ACCORDING ACCORDING TO ACCORDING
THE RATE OF THE NATURE OF TO THE SCOPE THE TO THE
INFLATION TIME-PERIOD OF OR COVERAGE GOVERNMENT’S CAUSES
OCCURENCE REACTION
1. MODERATE 1. WAR-TIME INFLATION 1. COMPREHENSIVE 1. OPEN INFLATION 1. CREDIT
INFLATION INFLATION INFLATION
i) Creeping
ii) Walking
2. RUNNING 2. POST-WAR INFLATION 2. SPORADIC 2. REPRESSED INFLATION 2. DEFICIT
INFLATION INFLATION INFLATION

3. GALLOPING 3. PEACE – TIME 3. PROFIT INFLATION

INFLATION INFLATION
4. HYPER-INFLATION 4. TAX INFLATION

5. FOREIGN TRADE
INFLATION

6. COST OR WAGE
INFLATION
DEMAND INFLATION
MODERATE INFLATION

✓ It is mild and tolerable form of inflation.

✓ It occurs when prices are rising slowly.
✓ Rate of inflation is less than 10 % annually.
✓ It is a single digit inflation rate.
✓ 3-4 percent rise per annum is a tolerable rate of
inflation in modern economies.
✓ 3 % annual rate of inflation is “CREEPING
INFLATION”.
✓ When it exceeds 10% it is “WALKING INFLATION”.
✓ Walking Inflation gives us a warning signal.
RUNNING AND GALLOPING INFLATION
❖When the movement of price accelerates
rapidly, running inflation emerges.
❖“RUNNING” inflation may record more than
100% rise in prices over a decade. ( more than
10 percent a year).
❖ When prices are rising at double digit or triple
digit rates of 20, 100 or 200 percent a year,
the situation may be described as
“GALLOPING” Inflation.
❖ galloping inflation is a serious problem.
HYPER - INFLATION
❖Prices rise every moment .
❖No limit to height to which prices rise.
❖In quantitative term, prices rise over 1000
percent in a year.
WAR, POST-WAR, PEACE-TIME INFLATION
WAR-TIME INFLATION
– Outcome of the exigencies of war on account of increased government
expenditure on defence( which is of unproductive nature)
– The government apportions a substantial production of goods and services
out of total availability for war which causes Downward shift in supply. As a
result, the inflationary gap may develop.

POST-WAR INFLATION
– Legacy of war.
– Happens when the disposable income of the community increases, when the
war-time taxation is withdrawn, or public debt is e paid, prices may rise.

PEACE-TIME INFLATION
– Prices rise during the normal times of peace.
– Often a result of increased government outlays on capital projects having a
long gestation period, so a gap between money income and real wage goods
develops.
– Thus when government expenditure increases, prices may rise.
COMPREHENSIVE AND SPORADIC INFLATION
From coverage or scope point of view:
COMPREHENSIVE INFALTION
✓When prices of every commodity throughout the
economy rise.
✓Refers to rise in general price level.

SPORADIC INFLTION
✓Cases in which averages of a group of prices rise
because of increases in individual prices due to
abnormal shortage of specific goods.
✓
OPEN AND REPRESSED INFLATION

OPEN INFLATION:
❖ When the government does not try to prevent the price rise.

❖ Inflation is open when prices rise without any interruption.

❖ The free market mechanism is permitted to fulfil its historic function

of rationing the short supply of goods and distribute them according
to the consumers’ ability to pay.

REPRESSED INFLATION
❖ When the government interrupts a price rise.

❖ It refers to those conditions in which price increasesare prevented at

the present time through an adoption of certain pressures like price
controls and rationing by government but they rise on the removal of
such control and rationing.
BASED ON THE CAUSES INDUCING INFLATION

CREDIT INFLATION:
Caused by excessive expansion of bank credit or money supply.

DEFICIT INFLATION
❖ When the government budgets contain heavy deficits and that are financial, through creating new
money, the purchasing power in the community increases and prices rise.

SCARCITY INFLATION

❖ Scarcity of real goods occurs an this may be artificially created by hoarding activities of unscrupulous
traders and speculators involving black marketing.
❖ Prices to go up.

PROFIT INFLATION ( Keynes)

❖ The price level f consumption goods is a function of the investment exceeding savings.
❖ Investment Boom is seen as Profit Boom.
❖ Entrepreneurs expect upward shifting of the marginal efficiency of the capital (MEC)during inflation.
❖ Entrepreneurs invest more even by buying at higher rates.

FOREIGN TRADE INDUCED INFLATION

: Pertaining to the Balance of Payments :
❖ EXPORT- BOOM INFLATION : rise in demand for exportables in foreign country.
❖ IMPROT PRICE-HIKE INFLATION : when prices of imported components rise.
TAX INFLATION
Year to year increase in commodity taxation such as excise duties and
sales tax.
Prices rise.

COST INFLATION
Emerges on account of a rise in the cost factor.
When money income ( wage rate particularly) expand more than real
productivity.
Prices rise.

DEMAND INFLATION
There is an excess of aggregate demand against the available aggregate
supply of goods and services, prices rise.
 DEMAND –PULL INFLATION
• Prices rise in response to an excess in aggregate
demand over existing supply of goods and services.
• Initially, increase in quantity of money when the
economy is operating at full employment.
• As quantity of money increases, rate of interest falls,
investments increase.
• Increased investment expenditure will soon increase
the income of various factors of production.
• Aggregate consumption expenditure will increase,
demand will increase. PRICES RISE.
• WHEN THE GENERAL MONETARY DEMAND RISES
FASTER THAN THE GENERAL SUPPLY IT PULLS UP
PRICES.
Demand –pull inflation is a situation where the total monetary
demand persistently exceeds total supply of real goods and services
at the current prices, so that prices are pulled upwards by the
continuous upward shift of the aggregate demand function.

• graph
CAUSES OF DEMAND-PULL INFLATION
1. INCREASE IN PUBLIC EXPENDITURE.
2. INCREASE IN INVESTMENT.
3. INCREASE IN MARGINAL PROPENSITY TO
CONSUME ( MPC).
4. INCREASING EXPORTS AND SURPLUS
BALANCE OF PAYMENTS
5. DIVERSIFICATION OF RESOURCES.
Eg. Form consumption goods to military etc.
 COST-PUSH INFLATION
• Increase in the cost of factors of production.
• Factors of production try to increase their share
of the total product by raising their prices.
• Such a price rise is termed as Cost-Push.
• Cost-Push inflation is induced by the wage
inflation process.
• Wages constitute nearly 70% of the total cost of
production.
• Any autonomous increase in costs of production
will increase price
• BUT it is wage-push pressures which to
accelerate the rising price spiral.
• graph
 CAUSES OF INFLATION
1. Over Expansion Of Money Supply.
2. Expansion Of Bank Credit.
3. Deficit Financing
4. Monetary Factors
1. High Non-development Factors
2. Huge Plan Investment.
3. Black Money
4. High Indirect Taxes
5. Non-monetary Factors
1. A High Population Growth
2. Natural Calamities
3. Speculation And Hoarding
4. High Prices Of Imports
5. Monopolies
6. Underutilization Of Resources
EFFECTS OF INFLATION