INFLATION

Inflation :-

Inflation is an increase in the general price level and thereby increase in cost of living which leads to decrease in purchasing power of consumers, wholesalers, etc. Here, cost of living means an average cost of buying a basket (or selected) of goods and services. As prices increase, a single unit of currency loses its value as it buys only few goods and services. This loss of purchasing power effects the general cost of living for the common public which is eventually leads to a slowdown in economic growth of the country. In order to curb this, the monetary authority of the country takes the necessary steps to keep inflation within acceptable limits, and keep the economy of the country running steadily.

Inflation rate :-

The inflation rate is the percentage (%) change in the price of a basket (selected) of goods and services consumed by households from one period to another period. The inflation indices i.e. Consumer Price Index or Wholesale Price Index can be used to calculate the value / rate of inflation between two particular periods, say months, or years. For example, assume that Consumer Price index in year 2019 is 262.53, and 2018 was 254.55. Find the inflation rate (%) changes. Then,

Inflation rate  = [(current period value  – Base period value) / Base period value] x 100

= [(262.53 – 254.55) / 254.55] x 100

= (7.98 / 254.55) x 100

= 0.031349 or 3.135%

In case pf prices or price index value is decreasing as compared to base / reference periods, then it is treated as Deflation.

Classification of Inflation :-

Inflation can be classified in 3 types.

1. Demand-Pull effect :-

It occurs when the overall demand for goods and services in an economy increases speedy than the economy's production capacity in a country. It creates the situation where higher demand and lower supply exists which leads to higher prices. For example, a tyres manufacturing company decides to cut down on production of tyres, then supply decreases, though higher demand which leads to increase prices of tyres, and finally it results to inflation. Moreover, an increase in money supply in economy also leads to inflation, why because, if more money available to individuals, then consumers can do higher spending on purchasing of goods and services, which increases demand and leads to increase in prices. Money supply can be increased by the central bank either by reducing the respective monetary policy rates i.e. CRR, SLR, etc. (available more money to the individuals), or by devalue (reducing the value of) the currency, or printing more currency, etc. Therefore, demand will increase in all such cases, and simultaneously the money loses its purchasing power.

2. Cost-push effect :-

This type of inflation occurs when increase in the prices of production process inputs. For example, an increase in labour cost to manufacture a product, increase in the cost of raw material, etc. This type of situation leads to higher cost for the finished goods and services, and result to inflation.

3. Built in inflation :-

This type of inflation occurs when suitable expectations by employees / workers. This means as the prices of goods and services are increased, workers / employees expect and demands more salaries / wages to maintain their cost of living. So, their increased wages result in higher cost of goods and services.

Inflation Indices :-

Inflation can be measured in several ways. The inflation indices were developed to understand the inflation levels for different types of population like consumers / retailers, wholesalers, producers, etc. the inflation indices for these type of population are known as consumer price index, Wholesale price index, Producer price index, etc. In India, the Consumer price index and Wholesale price index are two major indices for measuring inflation, whereas in USA, the Consumer price index and Producer price index are taking in to measure of inflation. Inflation indices are broadly classified as following two types in India

1. Wholesale Price Index (WPI) :-

WPI is percentage change in the wholesale prices of a basket of goods and services in the country. The WPI is a measure the weighted average prices of wholesale prices for primary articles, administered prices for fuel (crude oil) items, ex-factory prices for manufactured items (highest weightage is of chemicals and chemical products), etc. These prices can collect, based on voluntary, but WPI does not take into consideration the retail prices or prices of services. WPI covers all goods and services inclusive of intermediate goods transactions in economy. WPI taking in to consideration of around 700 items and 5500 price quotations to calculate inflation index. WPI computed by “Office of the Economic Advisor” in “Ministry of Commerce and Industry”. The base year of WPI is year 2012, and inflation rate released on monthly basis.

2. Consumer Price Index (CPI) :-

CPI is percentage change in the retail prices of a basket of goods and services consumed / purchased by households / individuals. The CPI is a measure that examines the weighted average of prices of a selected goods and services which are belongs to primary consumer needs such as food and beverages, narcotic substances, clothing, fuel & light, footwear, and medical care, etc. CPI is considering based on retail prices (which are relating to only consumers) inclusive of taxes and distribution cost. CPI prices can collect based on visiting the markets by the investigators. CPI taking in to consideration of around 450 items in rural category, and 460 items in urban category to calculate inflation index. CPI price data can be released by the following authorities :-

(a) The price data of industrial workers, agricultural labour, and rural labour are compiled and released by the “labour bureau” in the “ministry of labour and employment”, and,

(b) The price data of combination of rural and urban consumers / retailers is released by “Central Statistics Office (CSO)” in the “Ministry of Statistics and Programme Implementation”.

CPI is computed and released by central bank of India i.e. “Reserve Bank of India (RBI) in India”. The base year of CPI is year 2012, and inflation rate released on monthly basis.

Price Index :-

The weighted average of prices of a basket of goods and services at a current selected period relative to their prices in base period is called ‘price index’. The formula for obtaining the price index for current period  = [ (the total weighted average price of selected goods and services of current period / the total weighted average price of same goods and services in base period) x 100 ]. It should be remember that the price index for base period will always be 100 .

Is Inflation good or bad :-

We can understand inflation as either a good or a bad thing. Let us see the below two examples. First, the individuals who holds tangible assets, like property, may like to see some inflation as that increases the value of their assets which they can sell at a higher rate. So, in this case, inflation is good for those who wants to sell products, whereas, the buyers of such assets may not be happy with inflation. Second, Inflation can help lenders because they earn more interest. For example, if the price of a refrigerator increased from INR20,000 to INR22,000 due to inflation, the lender makes more money because 10% interest on INR22,000 is more than 10% interest on INR20,000. In addition, the extra INR200 and all the extra interest might take more time to pay off, meaning even more profit for the lender, whereas it is loss to the borrower. Therefore, an optimum level of inflation is required to keep the inflation value in an optimum and desirable range.

Controlling Inflation :-

A country’s monetary authority taking the important responsibility of monitoring the inflation. It can be done by implementing measures through monetary policy by determine the size and growth rate of the money supply in economy.

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written by

Chandra Sekhar