What Is Inflation?

• Inflation is an increase in the average level of

prices for goods and services. (where as
decrease is known as deflation)
• It could be expressed with the help of an
index, which shows how prices of goods and
services that is representative of the economy
as a whole are growing.
 Inflation & Deflation
• INFLATION IS BETTER
Inflation, though it redistributes income and wealth in favour of the rich and
causes economic inequalities, does not reduce national income. Deflation, on the
other hand, has the undesirable effect of reducing national income.
It is easy to control inflation by adopting various monetary and fiscal measures,
but it is very difficult to recover the economy from deflation.
Inflation is a post-full employment phenomenon, while deflation is an under-
employment phenomenon.
Inflation is a single evil because it redistributes wealth in favour of the rich people
arbitrarily. Deflation is a double evil because it not only redistributes wealth in the
same arbitrary manner, though in favour of the poor people, but also, reduces
output and causes unemployment.
Once deflation starts, it gathers momentum and the cumulative downward
process ultimately takes the economy into severe depression but in case of
inflation it is not so.
• Inflation is unjust but deflation is inexpedient
 How is Inflation caused?

Inflation is caused by a combination of following factors:

• The supply of money goes up.
• The supply of other goods goes down.
• Demand for other goods goes up.

Its divided in two types

• Demand - Pull Inflation

• Cost- Push Inflation

 Quantity Theory of Money: -
Fisher’s Transactions Approach
• Money as a means of buying goods and services. Amount of money
people have to hold to undertake a given volume of transaction over a
period of time . MV= PT Where, M= Amount of money
T= The volume of Transaction
P= Average price level per unit of transaction
V= Velocity of circulation of money
That shows a direct relationship between the quantity of money in
an economy and the level of prices of goods and services sold.
According to QTM, if the amount of money in an economy doubles,
price levels also double, causing inflation. In order to curb inflation,
money growth must fall below growth in economic output.
 Demand –Pull Inflation
The inflation resulting from an increase in aggregate demand at full
employment level which exceeds the supply of goods at current prices.

The reason for increase in AGGREGATE demand are:

– Increases in the money supply

Supply of money goes up, rate of interest falls, Investment will

increase, Increase income of factors of production, consumption
expenditure will increase, leads to increase in demand.

– Increases in Government purchases

Demand for other goods go up.

– Increases rest of the world’s expenditure on out commodities

– Increase in marginal propensity to consume

 Demand –Pull Inflation

AS

Price Level P2
P1
P AD2

AD1
AD

Y
Aggregate Demand and Supply
 Cost –Push Inflation
• Inflation can result due to decrease in aggregate supply

• Aggregate supply is the total value of the goods and services

produced in a country, plus the value of imported goods less the value of exports.

• The reason for decrease in supply are

– Wage – Push Inflation: An increase in wage rates

– An increase in the prices of raw materials
– Factors like GST may raise inflation (temporarily)
– Sudden devaluation of our currency may increase import cost which is to be
further used in production

These sources of a decrease in aggregate supply operate by increasing

costs, and the resulting inflation is called cost-push inflation
 Cost –Push Inflation
AS1

AS

P1

P
Price Level

AD

Y1 Y

Output
 Price Index
• Wholesale price index (WPI) - WPI gets
published from Office of the Economic
Adviser, Department of Industrial Policy and
Promotion (DIPP),Ministry of Commerce &
Industry, base year 2011-12 now
• Consumer Price Index (CPI) (Urban, Rural, and
All India)is done by Central Statistics Office
(CSO) and gets released by Ministry of
Statistics and Programme Implementation
(MOSPI).
 CPI
MOSPI has revised the Base Year of the
Consumer Price Index (CPI) from 2010=100 to
2012=100.
CPI (Industrial Workers), CPI (Agricultural
Labour) and CPI (Rural Labour) are a set of
Indices released by the Labour Bureau, Ministry
of Labour. Some States also compile variants of
CPI and WPI indices at the State level
 WPI and CPI

• The WPI series mainly tracks the movement of

producer and bulk transaction prices and its weights
are based on the value of output in different sectors of
the economy. The CPI basket is based on consumer
expenditure estimates and tracks inflation at retail level
or the prices consumers pay. CPI basket consists of
commodities as well as services like health and
education which are not included in the WPI basket
• The weighting process of the two series vary
significantly. For Example - the weight of total food
items in the WPI is24.3 percent as compared to 45.9
percent in the CPI series.
 Construction methodology
• Currently WPI takes 697 items in to account. But
for specific sectors here are the weights
according to their importance in the economy
(BASE YEAR 2011-12)
• Manufactured articles - 65%
• Primary article - 22%
• Fuel, power, light and lubricants - 13%
CPI construction
https://dbie.rbi.org.in/DBIE/dbie.rbi?site=home
 WPI in the new base year

Comparative Weights, No. & Items and No. of Quotations in old and new WPI series Major Group/Group

Weight No. of Items No. of Quotations

Base year -> 2011-12 2004-05 2011-12 2004-05 2011-12 2004-05

All Commodities 100 100 697 676 8331 5482

I Primary Articles 22.61756 20.11815 117 102 983 579

II Fuel & Power 13.1519 14.91021 16 19 442 72

III Manufactured Products 64.23054 64.97164 564 555 6906 4831

 Price index (Fisher’s index is the square root of
the product of following two)

• The Paasche index and Laspeyres index

 CPI based on Consumer
expenditure survey
annual inflation (dec vs. annual inflation (dec vs.
inflation inflation
dec) dec)
CPI India 2015 6.32 % CPI India 2005 5.57 %
CPI India 2014 5.86 % CPI India 2004 3.78 %
CPI India 2013 9.13 % CPI India 2003 3.72 %
CPI India 2012 11.17 % CPI India 2002 3.20 %
CPI India 2011 6.49 % CPI India 2001 5.16 %
CPI India 2010 9.47 % CPI India 2000 3.48 %
CPI India 2009 14.97 % CPI India 1999 0.47 %
CPI India 2008 9.70 % CPI India 1998 15.32 %
CPI India 2007 5.51 % CPI India 1997 6.29 %
CPI India 2006 6.53 % CPI India 1996 10.41 %
 Headline and Core inflation : WPI
Inflation in WPI Broad Groups (in per cent) (Base:2004-05)
Weights 2012-13 2013-14 2014-15 2015-16
(Apr-Dec)P
Headline 100 7.4 6 2 -3
Primary articles 20.1 9.8 9.8 3 -0.5
Fuel and power 14.9 10.3 10.2 -0.9 -12.6
Manufactured products 65 5.4 3 2.4 -1.3
Non-food manufactured (core) 55 4.9 2.9 2.4 -1.5
All food 24.3 9.3 9.4 4.9 1.9
Source: Office of Economic Adviser,
DIPP.
Note: P: Provisional.
 Headline and Core inflation : CPI
Inflation in CPI (Combined) Broad Groups (in per cent)
Weights Weights 2012-13 2013-14 2014-15 2015-16
(Apr-Dec) P
Base 2010 2012 2010 2010 2012 2012
Headline 100 100 10.2 9.5 5.9 4.8
Food & beverages 47.6 45.9 11.9 11.2 6.5 4.9
Fuel & light 9.5 6.8 8.5 7.4 4.2 5.5
Non-food non-fuel (core) 42.9 47.3 8.8 8.1 5.6 4.5
Food (CFPI*) 42.7 39.1 12.2 11.3 6.4 4.6
Source: CSO
Notes:* Consumer Food Price Index; P: Provisional
 CPI
Headline inflation based on different indices (in per cent )
2010-11 2011-12 2012-13 2013-14 2014-15 2015-16*
(Apr-
Dec)
WPI 9.6 8.9 7.4 6 2 -3
(combine
CPI d) - - 10.2 9.5 5.9 4.8
CPI (IW) 10.4 8.4 10.4 9.7 6.3 5.6
CPI (AL) 10 8.2 10 11.6 6.6 4.2
CPI (RL) 10 8.3 10.2 11.5 6.9 4.4
Source: Department of Industrial Policy and Promotion (DIPP) for WPI,
Central Statistics Office (CSO) for CPI (combined) and Labour Bureau for
CPI(IW), CPI (AL) and CPI (RL).
Notes: *WPI and CPI (Combined) figures are provisional; AL stands for
agricultural labourers and RL stands for rural labourers.
 Unemployement
• Disguised Unemployment- - it is a situation in which
more people are doing work than actually required
like our agricultural labourers
• Seasonal Unemployment – Seasonal cultivation
stops to create so
• Cyclical Unemployment - normally takes place due
to business cycles
• Structural Unemployment - caused by the skill gap
• Frictional Unemploymenti - is due to immobility of
labour, lack of correct and timely information,
seasonal nature of work. etc.
 Short Run relationship between
Inflation and unemployement –
Phillip’s Curve
Inflation

Unemployement
 Deflation
• In economics, deflation is a decrease in the general price
level of goods and services.

• Deflation occurs when the inflation rate falls below zero percent, resulting
in an increase in the real value of money – a negative inflation rate.

• This should not be confused with disinflation, a slow-down in the inflation

rate (i.e. when the inflation decreases, but still remains positive).

• Inflation reduces the real value of money over time, conversely, deflation
increases the real value of money. Money refers to the functional currency
(mostly unstable monetary unit of account) in a national or regional
economy.
 Hyperinflation
• In economics, hyperinflation is inflation that is very high or "out of
control", a condition in which prices increase rapidly as a currency
loses its value.

• Many of the worst periods of hyperinflation are preceded by deflation.

• With high levels of government debt, severe cases of deflation cause a

loss of confidence in the nation's currency by shrinking the economy
and making the government's debt appear increasingly unsustainable.
The loss of confidence then causes the flow of money to speed up as
individuals become desperate to exchange cash for real goods as fast
as possible, producing hyperinflation.
 Stagflation
• A condition of slow economic growth and relatively high
unemployment - a time of stagnation - accompanied by a
rise in prices, or inflation.

• Stagflation occurs when the economy isn't growing but

prices are, which is not a good situation for a country to
be in.

• This happened to a great extent during the 1970s, when

world oil prices rose dramatically, fuelling sharp inflation
in developed countries.