ECONOMICS FOR MANAGERS

PSG INSTITUTE OF MANAGEMENT MBA 2011-13 BATCH I Trimester

Session XVIII- For Batch C and D Business Decisions and Government -4 -Inflation

Inflation
We saw in the 15th session what inflation is.

Inflation happens when the Aggregate

Demand curve gets shifted to the right due to whatever reasons and in that process pushing up the general price level. If the Aggregate Demand curve keeps shifting month after month the economy will suffer from inflation. Inflation is an increase in the price of a basket of goods and services that is representative of the economy as a whole.
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Two ways of looking at inflation

Inflation in economic terms is the percentage by which demand is higher than the supply. For example, if the inflation rate is 5% for a particular item, it means that the demand is 5% more than the total supply of that particular item. 2. Inflation can also be defined as an increase in the general level of price of goods and services over a period of time. It is measured as an annual percentage increase and is a major concern for common people. It negatively affects the purchasing power of money as you can buy less of goods and services with same EFM Faculty P.Uday 18th October 2011 3 amount of Shankar money.
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Facts to remember about inflation

Historically you will not find any period when

inflation was not present. While deflation (falling prices) is normally associated with low rates of growth and even recession, on the contrary it would seem that for a healthy economy inflation is required. While any rate below 4% or 5% inflation does not necessitate pressing the alarm bell, any rate above 5% is seen as a cause for concern.

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Why is a high rate of inflation undesirable?

Redistribution of income and wealth:

Redistribution of wealth may take place from creditors to debtors. This is because debts lose real value with inflation. During times of inflation those with economic powers tend to gain at the expense of the weak, particularly those with fixed incomes. Balance of payments: If a country has a higher rate of inflation than its major trading partners, its exports will relatively become expensive and imports relatively cheaper. As a result, balance of trade will affect for eg. employment in export industries. This will eventually affect exchange rates too.
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Why is a high rate of inflation undesirable?

Uncertainty of the value of money and prices:

As markets are unpredictable prior information on values of money or prices are difficult to get. While small increases in prices can be faced by consumers, excessive inflation in the form of hyper-inflation may result in money becoming worthless and people may resort to barter. In such situations rational decision making is near to impossible. High Inflation rates affect economic growth and level of investment: Studies on comparison of inflation rates and per capita GDPs have proved that persistent inflationary tendencies affect economic growth and Faculty P.Uday Shankar EFM levels of investment. 18th October 2011

Causes of Inflation

Demand Pull factors Cost Push factors

Pricing Power factors

Import cost factors Excessive growth in the money supply Skewed Inflation or Skewflation

EFM Faculty P.Uday Shankar

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Causes of Inflation- Demand Pull Inflation This happens when the economy is buoyant and there is a high aggregate demand, in excess of the countrys ability to supply. Price increases as aggregate demand exceeds aggregate supply. As supply needs to be increased, there will be a demand on factors of production and as a chain effect factor rewards will increase. This can be described as too much money chasing too few goods. India being a growing economy has experienced this type of inflation for years. Almost all industries in India face demand pull inflation especially when it comes to the technology driven industry like Automobile, Consumer Electronics.
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Causes of Inflation- (contd.)

Cost Push Inflation: This is also known as supply shock inflation. When there is shortage of a particular product it causes the price levels to rise which has a ripple effect on the economy thus leading to inflation. Cost Push Inflation happens when the cost of factors of production rise regardless of whether they are in short supply or not. Egs. Sudden increase in raw materials cost, wage increases,. Pricing Power Inflation: This type of inflation is caused by business houses who tend to increase prices to increase their profit margins. It is more common in oligopolistic economies.
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Causes of Inflation- (contd.) Import Cost Push Inflation:

This inflation happens when the cost of essential imports rise regardless of whether or not they are in short supply. Eg. Price rise in crude oil prices.

Excessive Growth in Money Supply:

Monetarists argue that inflation can be caused by an increase in money supply. Eg. When government makes pay commission increments and arrear payments

Skewed Inflation or Skewflation

The recent rise in inflation has been termed as skewflation or skew inflation. This term has been coined observing the unusual inflation wherein there was huge inflation in the food sector with the non-food sector remaining more or less constant.
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How inflation is calculated

How is inflation calculated in India? India uses the Wholesale Price Index (WPI) to calculate

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inflation. Most developed countries use the Consumer Price Index (CPI) to calculate inflation. What is Wholesale Price Index (WPI)? Wholesale Price Index (WPI) is the index that is used to measure the change in the average price level of goods traded in the wholesale market. In India, a total of 435 commodities data on price level is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions. WPI is published on a weekly basis in India. What is Consumer Price Index (CPI)? CPI is a statistical time-series measure of a weighted average of prices of a specified set of goods and services purchased by consumers. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation. In India, CPI is published on a monthly EFM 18th October 2011 basis.Faculty P.Uday Shankar

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Case Study: The Wall Street Protestors

Here Are The Four Charts That Explain What The

Protesters Are Angry About... Henry Blodget

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