ECONOMICS C CHAPTER-10. INFLATION Class:X

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1 ECONOMICS C CHAPTER-10. INFLATION Class:X INFLATION is commonly understood to be a situation in which prices of goods and services persistently rise at a fast pace. A substantial rise in price or rise in price at fast rates is called inflation. One time rise in the price level does not mean inflation. It is the persistent rise or price increase continuously over a long period of time level of goods and services in the economy. Features of Inflation (i) (ii) (iii) Inflation is a monetary phenomenon: When money supply in the economy exceeds as normal productive capacity, it leads to persistent rise in prices. Inflation occurs when the volume of money increases faster than the available supply. Inflation is post-full employment phenomenon: True inflation starts only after full employment. After full employment, when there is an increase in the demand for goods and services with no corresponding increase in supply of output. Prices start rising. Inflation means rise in overall price level: It refers to increase in prices of many goods and services simultaneously. Prices of some commodities may even fall during inflation. But overall price level rises during inflation. TYPES OF INFLATION i. Creeping inflation When the rise in prices is very slow like that al a snail or creeper, it is called creeping inflation. In terms of speed, prices rise about 2 per cent annually which is regarded safe and essential for economic growth because it keeps the economy away from stagnation. ii. Walking Of Trotting Inflation: When price rise moderately and the annual inflation rate is in single digit, It is called walking or Trotting inflation. It is, rate of rise in price, is in the intermediate range of 3 to 6 per cent per annum or less than 10 per cent. Such inflation is warning signal for the government to control it before it turns into running inflation. iii. Running inflation: When price rise rapidly at a rate or speed of around 10% to 20% per annum, it is called running inflation. It affects the middle class adversely. Their economic position becomes worse. Government should take necessary and immediate steps to control it. iv. Hyper inflation: When prices rise very fast at double or triple digit rates from more than 20 to 100 per annum or more it is usually called hyper inflation or galloping inflation. Such a situation brings total collapse of the monetary system because of the continuous fall in the purchasing power of money. This kind of inflation took place in Germany after the First World War and in China after the Second World War. ( 1 )

2 DEMAND PULL INFLATION Inflation originating from demand factors is commonly referred to as demand pull inflation. Demand Pull Inflation Demand pull inflation refers to a situation in which prices rise because the demand for goods and services exceeds their total supply available at current prices. It is also known as 'excess demand inflation'. Demand pull inflation may be defined as a situation where the aggregate demand exceeds the economy's ability to supply the goods and services at the current prices, so that the prices are pulled up by the excess demand. Causes of Demand Pull Inflation. (i) (ii) (iii) (iv) (v) Increase in Money Supply Increase in money supply leads to increase in aggregate demand. Supply of money includes currency with the public and demand deposit at banks. This is money in spendable form. This trend increases demand for goods and services within the economy. Increase in Disposable Income When the disposable income of the people increases it raises their demand for goods and services, leading to demand pull inflation. This can happen when there is low taxation or if interest rates are too low to attract people to save and invest rather than spending. Increase in Population: Increase in population is for rise in prices. Increase in population means increased demand for consumer goods. It increases the aggregate demand for goods and services and puts pressure on the existing supply of goods and services. Increase in public expenditure Government has to spend a large amount of money for meeting requirements of defence and for various programmes for the country s economic and social development. This has raised aggregate demand for goods and services. Black money The existence of large amount of black money in all countries increases the aggregate demand. It is a general tendency of people spending such unearned money extravagantly, thereby creating unnecessary demand for commodities. This tends to raise the price level further. COST PUSH INFLATION Another explanation of inflation is in terms of forces operating on the cost side or the supply side. It is known as supply or cost theory of inflation. According to this theory, the prices instead of being pulled up by demand factors (i.e., excess demand) may also be pushed up as a result of rise in the cost of production. ( 2 )

3 Cost push inflation theory is the modern of inflation; it is also called as the 'new inflation. This type of inflation emerges due to increase in the costs. Causes of Cost Push Inflation. (i) Rise in Wages: Rise in wages has been considered as the main determinant of cost push inflation. This is because in modern times, workers have organised themselves into strong trade unions which have succeeded in getting higher wages for their members. (ii) Increase in the Price of Basic Materials: Cost push inflation is also caused by increase in the prices of some basic materials, such as steel, basic chemicals, oil, etc. Since, these materials are used directly or indirectly in almost all the industries, any increase in their prices affect the whole of the economy and the prices everywhere tend to increase. (iii) Higher Taxes: Another important cause of cost push inflation is the imposition of higher taxes on commodities, like excise duties, sales tax etc. These taxes are largely passed over by the producers to the consumers by the amount of taxes. (iv) Increase in profit margin: High profit margin on the part of the producer due to their monopolistic position, raises the cost of production which in turn pushes up the prices. This kind of inflation is termed as profit induced inflation. (v)rise in international prices: Price rise in one of the trading countries has its effect on other countries as well.inflation in one country spreads to other countries through trade.ex. Periodic increase in oil prices by the OPEC countries has significant effect on the general price level in all petroleum importing countries. EFFECTS OF INFLATION Effects on Purchasing Power Effects on Production Effects on Distribution. Effects on Purchasing Power of Money: By purchasing power of money, we mean the amount of goods and services that a unit of money can buy.it is also called real income. Inflation reduces the purchasing power of money. In the times of inflation, people will be able to buy lesser and lesser amount of goods and services than before. Inflation, thus, reduces the value of money. Again, money can perform its functions smoothly only when its own value remains stable. ( 3 )

4 Effects on Production: A moderate rise in prices (i.e., creeping inflation) has a favourable effect on production. Rising prices increase the profit expectations within the business community. Businessmen are induced to invest more and, as a result output and employment increase. Till the stage of full employment is reached, moderately rising prices prove beneficial for production. But a state of running or hyper inflation creates uncertainty in the economy and proves very harmful to production. (i) Misallocation of Resources : Inflation leads to maladjustments in production. Producers divert their resources from the production of essential commodities to non- essential (i.e., luxury goods) from which they expect higher profits. (ii) Reduction In Saving : When prices rise rapidly, more money is now needed to buy the same amount of goods and services than before. It thus reduces saving and hence investment. As a result, production is adversely affected. (iii) Discourages Foreign Capital : Inflation discourages the inflow of foreign capital into the country. Foreigners do not like to, invest in those countries where prices a, rising. Rising cost of raw materials and other inputs make foreign investment less profitable. (iv) Hoarding : During inflation, hoarding of larger stocks of goods becomes profitable. As a result of this, the available supply of good in relation to demand decreases. This results in black-marketing. The producer then sells their goods in black market which increases inflation. (iv) Fall in Quality Inflation tends to create a sellers' market. Sellers have command on price because of excess demand. Therefore, sellers do not bother much about the quality of goods produced, instead they concentrate more on earning profit. Effects on Distribution (i) Debtors and creditors: Debtors borrow from creditors to repay with interest at some future date. Changes in price level affect them differently at different time periods. During inflation when the prices rise and the real value of money goes down, the debtors pay back less in real terms than what they had borrowed and thus, to that extent they are gainers. On the other hand, the creditors get less in terms of goods and services than what they had lent and lose to that extent. (ii) Wage earners and salaried persons or fixed income group : Wage earners generally suffer during inflation, despite the fact that they obtain a wage rise to counter the rise in the cost of living. However, wages do not rise as much as the rise in price of those commodities which the workers consume. Further, wages are allowed to rise much later than the rise in prices. If the workers are organized (trade Unions), they may not suffer much during inflation as compared to those who are not organised. The hardest hit is the person who receives fixed income or salaried class. Persons who live on past savings, pensions, etc., suffer during periods or rising price as their incomes remain fixed. During inflation their purchasing power of money falls due to increase in price. In this way the economic burden keeps on increasing iii) Business community: Businessmen tend to gain during inflation because a. Prices of their inventories (stock of goods and raw material) go up and thereby increasing their profits. b. Prices rise at a faster rate than the cost of production. c. They are generally borrowers of money for business purposes thus they gain in terms of real income while repaying. (Inflation makes the rich (i.e., the business community) richer. Justify (iv) Investors: Inflation has a mixed effect on the investors. a. Investors in fixed interest earning assets (like bonds, debentures and deposits) are the losers because Small investors who invest their money in bonds, debentures and deposits with the ( 4 )

5 commercial banks tend to lose because they receive only a fixed interest income from such investment b. Investors in shares of the companies tend to gain during inflation because they get more dividend on account of high profits made by joint stock companies during inflation. (v) Farmers : a. Big Farmers generally gain during periods of inflation, because they can obtain better prices for their crops during inflation. Also, farmers are generally debtors as they borrow funds/ money for agricultural purposes. b. Small farmers do not gain much during inflation as the major portion of their produce is not marketed but instead, kept for self-consumption and they have to purchase inputs, like seeds, fertilisers, insecticides, etc., at higher prices during in CONTROL OF INFLATION Main measures to control inflation are Monetary Measures, Fiscal Measures, Other Measures. Monetary Measures Inflation is primarily a monetary phenomenon. Hence, the most effective measure to control inflation is to check the flow of money supply and credit in the economy. These include the following. 1. Control over Money Supply : To check inflation, it is suggested that government should impose strict restrictions on the issue of money by the central bank. 2. Control on Credit : The central bank of the country should take necessary steps to contract credit because credit forms a major part of money supply. More credit means more supply of money. For this, the central bank can sell government securities in the open market and thus reduce the excess purchasing!, power in the market. 3. Issue of New Currency : It is an extreme monetary measure. Under it, new currency is issued in place of the old currency; one rupee note can be exchanged for a number of notes of the old currency. Such a measure is adopted only when there is an excessive money supply and hyper inflation in the country Fiscal Measures These include the following. 1. Reduction in Public Expenditure Public expenditure is an important component of aggregate demand; steps should be taken to reduce unnecessary government expenditure on non-developmental activities. For example, expenditure on defence and unproductive activities should be reduced. Such expenditure only increases the purchasing power in the hands of people without any corresponding increase in output. 2. Increase in Taxes : To cut private consumption expenditure, there should be increase in taxes. Both direct and indirect taxes can be used for this purpose. Direct taxes (e.g., income tax, corporate tax, etc.) reduce the disposable income of the tax-payers and thereby reduce their consumption expenditure. Likewise, indirect taxes (e.g., sales tax, excise duties, etc.) also reduce the aggregate demand by making the goods costlier. Moreover, the government should also penalise the tax evaders by imposing heavy fine. Such measures are bound to be effective in controlling inflation. ( 5 )

6 3. Public Borrowings : Public borrowing can also be used in controlling inflation. Through public borrowings, the government takes away the excess purchasing power from public. This will reduce aggregate demand and hence the price level and inflation level 4. Policy of Surplus Budgets: In order to control inflation, the government should give up deficit financing and, instead, have surplus budgets. Government should avoid deficit financing (i.e., financing of the deficit budget, as far as possible by using new currency.) Other Measures These include the following: 1. Price Control and Rationing : Under Price controls, the government fixes maximum price at which certain commodities can be sold. No one can charge more than prices. Therefore, price control policy is generally accompanied by rationing. Under rationing, government fixes the quota of certain commodities to the consumers at the controlled price. 2. Increase in Production : Inflation arises should be diverted from the production of luxury goods to the production of mass consumption goods like food, clothing, vegetable, oil, sugar, etc. All possible help in form of latest technologies, raw materials, subsidies, etc., should be provided by the government to the producers in this regard. INFLATION IN INDIA Inflation in India is caused by the international oil prices. Rising prices of manufactured products such as food products, cement, iron and steel etc. Rising price of cash crops like raw cotton, oilseeds, sugarcane etc. Inflation rate in india is 6.46%p.a.in 2014.this is a reduced figure from the rate being 9.6% in 2011(as per Indian Ministry of statistics and programme impementation) Both demand side and supply side factors are responsible for this. Decrease in food grain supply, increase in demand due to increase in income of the people are source of the reasons behind Indian inflation. Hoarding of some essential items in anticipation of increase in price in future by some traders too is cited as one of the reasons for price rise in India. Inflation in India is measured on the basis of wholesale price index (WPL) with a base year. ( 6 )