Inflation
Radha. R
AGENDA
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What is Inflation?
Degrees of Inflation
Types of Inflation
Cost Push Inflation
Types of Cost Push Inflation
Phillips curve – is unemployment inflated?
Inflation and your investments
Policies to tackle inflation
Conclusion
References
WHAT IS INFLATION?
 Inflation is an increase in the overall level of prices. At what rate do
the prices go up?
 The rate at which the prices change is called the "rate of inflation".
 When inflation goes up, there is a decline in the purchasing power of
money
 Example:
If the price of Product X is Rs.100 this year and next year the price
becomes approximately Rs.104 then the rate of inflation is 4%
If the price of Product X is Rs.80 then after a year with a rate of
inflation of 4% the price will go up to (80 x 1.04) = 83.2
DEGREES OF INFLATION
There are three degrees of inflation:
• Mild inflation: is a slow rise in price level of no more than 5 percent
per annum. It is associated with a low level of unemployment and is
during the upswing phase of a trade cycle.
 Strato-inflation: the inflation rate ranges from about 10 percent to
several hundred per cent
 Hyper-inflation: is a very rapidly accelerating inflation which is 20
percent above. This usually leads to the breakdown of the country's
monetary system as the existing currency may have to be withdrawn
and a new one introduced
TYPES OF INFLATION
• Demand-pull or excess demand Inflation: It occurs when the total
demand for goods and services in an economy exceeds the available
supply, so the prices for them rise in a market economy.
E.g. War produces this type of inflation because demand for war
materials and manpower grows rapidly
• Cost-push inflation: This is caused when there is a supply shock.
The best example to describe cost-push inflation is the oil shock in
the 1970s.
When the OPEC raised oil prices, the United States was forced to pay
higher prices. Because oil is used in essentially every industry, this
sent supply shockwaves throughout the United States, and overall
prices went up, while wages paid stayed the same
• Pricing power or Administered Price Inflation: It occurs whenever
businesses in general decide to boost their prices to increase their
profit margins. This occurs when the economy is booming and sales
are strong. It might be called Oligopolistic Inflation
(because it is oligopolies that have the power to set their own prices
and raise them when they decide the time is ripe)
• Sectoral Inflation: When various factors affect/hits a basic industry
causing inflation.
E.g. Steel or oil , that raises costs of the industries using steel or oil,
and forces up prices there also, so inflation becomes more widespread
throughout the economy, although it originated in just one basic
sector.
COST-PUSH INFLATION
• Aggregate supply is the total volume of goods and services produced
by an economy at a given price level. When there is a decrease in the
aggregate supply of goods and services stemming from an increase in
the cost of production, we have Cost-push inflation.
• Cost-push inflation basically means that prices have been “pushed
up” by increases in costs of any of the four factors of production
(labor, capital, land or entrepreneurship).
EXAMPLE
• A company may need to increases wages if laborers demand higher
salaries (due to increasing prices and thus cost of living) or if labor
becomes more specialized. If the cost of labor, a factor of production,
increases, the company has to allocate more resources to pay for the
creation of its goods or services. To continue to maintain (or increase)
profit margins, the company passes the increased costs of production
on to the consumer, making retail prices higher.
HOW COST-PUSH INFLATION WORKS?
• The equilibrium point is where the AS curve meets the AD curve.
• The aggregate supply curve shifts left ie. From AS curve to AS2 because of the
increase in the cost.
TYPES OF COST-PUSH INFLATION
 Wage Push Inflation: Situations where in a rapid increase in the
workers’ wages causes the rate of inflation to increase. When
workers’ incomes rise, they have additional money to spend. As those
dollars go into the economy, the competition for goods increase and
prices move upward.
 Import Price Push Inflation: Higher import prices could result from
a fall in the exchange rate. The higher cost of imported raw materials
will raise the cost of production which may be passed on to the
customers in the form of higher price.
 Profit Push Inflation: This occurs when the prices are forced up as a
result of which the firms raise their profit margin.
 Tax-Push Inflation: Increases in income due to inflation can push
people into higher tax brackets, a phenomenon known as bracket
creep. In effect, inflation can increase people’s tax liability without
any change in tax law.
PHILLIPS CURVE
• The Phillips Curve is a relationship between unemployment and
inflation discovered by Professor A.W.Phillips. The relationship was
based on observations he made of unemployment and changes in
wage levels from 1861 to 1957.
• He found that there appeared to be a trade-off between
unemployment and inflation, so that any attempt by governments to
reduce unemployment was likely to lead to increased inflation.
PHILLIPS CURVE GRAPH
This relationship however, in the 1970s appeared to break down as the economy
suffered from unemployment and inflation rising together (stagflation).
Stagflation - A condition of slow economic growth and relatively high
unemployment - a time of stagnation - accompanied by a rise in prices, or inflation,
which is not a good situation for a country to be in.
INFLATION AND INVESTMENTS
• Inflation is greatly feared by investors because it grinds away at the
value of your investments.
Example
• Putting simply, Rs 45,000 today is not the same as Rs 45,000 in 1 or
10 years. It is crucial to include measures of expected inflation when
calculating your expected return on investment (how much you make
on your investment).
• So, when you make an investment, make sure that your rate of return
on the investment is higher than the rate of inflation in your country
• Rate of Inflation – for the year 2006-07 is around 5.5 – 6 %
POLICIES TO TACKLE INFLATION
Demand Side Policy:
• Fiscal Policy: refers to the expenditure a government undertakes to
provide goods and services and to the way in which the government
finances these expenditures.
A government's taxation policy. Tax enables the government to raise
revenue in order to provide public goods which would not otherwise
be provided by the market, such as a police force, national defense,
and so on.
• Monetary Policy: refers to efforts to fight inflation or otherwise
control or stimulate the economy by controlling the availability of
spending money to company and consumers.
Actions by the Federal Reserve to control the money supply
Supply side policy:
Aim: To reduce the rate of increase in the costs.
This is done by • Restraining monopoly influences on the prices and incomes
Policies to restrict the activities of trade unions, mergers and takeover.
• Restricting policies to increase productivity
Giving tax incentives, encouraging R & D
CONCLUSION
Is inflation good for the economy?
In an word , YES , But, it is essential that organizations like
the Fed keep a close eye on its status and make the necessary
adjustments.
REFERENCES
Websites
• http://searchwarp.com/swa87474.htm
• http://www.yourdictionary.com/
• http://www.bized.co.uk/virtual/bank/economics/mpol/inflation/causes
/theories4.htm
• http://www.harpercollege.edu/mhealy/eco212i/lectures/fiscpol/fp.htm
• http://www.investopedia.com/articles/05/012005.asp
Books
• Economics in Context : By Susan Grant, Chris Vidler
• Economics - by Paul R. Krugman